Question 1

Holding other things constant,the additional funds required for financing the firm's operations would be reduced with an increase in the firm's
A) Dividend payout ratio.
B) Profit margin.
C) Cost of external funds.
D) Expected growth rate in sales.
E) Tax rate.

Accepted Answer

An increase in the firm's profit margin means the firm is generating more profit from its sales, which in turn reduces the need for additional external financing to support operations. Higher profits can be used to fund growth and operational needs internally.

Question 2

The projected balance sheet forecasting method produces accurate results unless which of the following condition(s)is (are)present?
A) Fixed assets are "lumpy."
B) Strong economies of scale are present.
C) Excess capacity exists because of a temporary recession.
D) Answers a,b,and c all make the projected balance sheet method inaccurate.
E) Answers a and c make the projected balance sheet method inaccurate,but,as the text explains,the assumption of increasing economies of scale is built into the projected balance sheet method.

Accepted Answer

The projected balance sheet is not accurate if fixed assets are "lumpy," which means that the assets cannot be divided into smaller parts, creating difficulties in valuing them. Strong economies of scale also affect the projection, as increasing production may lead to lower per-unit costs, but the balance sheet projection assumes per-unit costs will remain constant. Excess capacity due to a temporary recession also affects projections as it may cause a decrease in asset values. Therefore, all three conditions mentioned in choices A, B, and C make the projected balance sheet method inaccurate. Answer E is incorrect as it states that only choices A and C make the projected balance sheet method inaccurate, which is not entirely true as choice B also affects the projection.

Question 3

If a firm's degree of total leverage (DTL)is 8.0,which of the following must be correct?
A) The firm must have fixed operating costs.
B) The firm must have fixed financial costs.
C) The firm must have both fixed operating costs and fixed financial costs.
D) The firm must have some fixed costs,but not enough information is given to determine whether the fixed costs are operating,financial,or both.
E) With the information given,we cannot tell whether the firm has any fixed costs (either operating or financial)at all.

Accepted Answer

The degree of total leverage (DTL) indicates the sensitivity of a firm's earnings per share to changes in sales. A DTL of 8.0 suggests that the firm has some fixed costs, but it does not specify whether these are operating or financial costs.

Question 4

Which of the following is a key determinant of financial leverage?
A) Level of debt.
B) Technology.
C) Labor costs.
D) Amount of fixed assets used by the firm.
E) Variable cost of goods sold.

Accepted Answer

Financial leverage is determined by the level of debt a firm has. The more debt a firm has, the higher its financial leverage will be. Other factors such as technology, labor costs, fixed assets, and variable costs can impact a firm's profitability, but they do not directly affect its financial leverage.

Question 5

The degree of operating leverage for ABC Inc.is 3.5,and the degree of operating leverage for XYZ Corporation is 7.0.According to this information,which firm is considered to have greater business risk?
A) ABC Inc.
B) XYZ Corporation.
C) The degree of operating leverage is not a measure of business risk,so it is not possible to tell which firm has the greater business risk given the above information.
D) To determine which firm has the greater business risk,we need to know the operating income (NOI or EBIT)of each firm.XYZ Corporation would have less business risk if its operating income is at least twice that of ABC Inc.
E) None of the above is a correct answer.

Accepted Answer

The degree of operating leverage (DOL) measures the sensitivity of operating income (EBIT) to changes in sales. A higher DOL means that operating income will change more for the same change in sales. Therefore, a higher DOL indicates a greater business risk. As XYZ Corporation has a higher DOL than ABC Inc., it implies that XYZ Corporation has greater business risk. Option A is incorrect because ABC Inc. has a lower DOL, indicating lower business risk. Option C is incorrect because DOL is a measure of business risk. Option D is incorrect because the operating income of each firm is not relevant to determining the DOL and business risk. Option E is incorrect because option B is the correct choice.

Question 6

The degree of financial leverage for ABC Inc.is 2.5,and the degree of financial leverage for XYZ Corporation is 1.5.According to this information,which firm is considered to have greater financial risk?
A) ABC Inc.
B) XYZ Corporation.
C) The degree of financial leverage is not a measure of financial risk,so it is not possible to tell which firm has the greater financial risk given the above information.
D) To determine which firm has the greater financial risk,we need to know the operating income (NOI or EBIT)of each firm.XYZ Corporation would have less financial risk if its operating income is at least twice that of ABC Inc.
E) None of the above is a correct answer.

Accepted Answer

The degree of financial leverage (DFL) measures the percentage change in earnings per share (EPS) that results from a percentage change in earnings before interest and taxes (EBIT). The higher the DFL, the greater the financial risk because a small change in EBIT can lead to a larger change in EPS. ABC Inc. has a higher DFL compared to XYZ Corporation, which indicates that ABC Inc. has greater financial risk. Therefore, option A is the correct answer. Option B is incorrect because XYZ Corporation has a lower DFL and, therefore, lower financial risk. Option C is incorrect because DFL is a measure of financial risk. Option D is incorrect because the operating income is not necessary to determine which firm has greater financial risk.

Question 7

Which of the following statements is correct?
A) One of the key steps in the development of pro forma financial statements is to identify those assets and liabilities which increase spontaneously with net income.
B) The first,and most critical,step in constructing a set of pro forma financial statements is establishing the sales forecast.
C) Pro forma financial statements as discussed in the text are used primarily to assess a firm's historical performance.
D) All else equal,if a firm operates at full capacity,the greater its payout ratio,the less additional funds that will be needed for a particular growth in sales.
E) The projected balance sheet forecasting method produces accurate results when fixed assets are lumpy and when economies of scale are present.

Accepted Answer

The first step in constructing a set of pro forma financial statements is to establish the sales forecast, as the forecasted sales will impact all other items on the statements. Option A is incorrect as the key step is to identify those assets and liabilities that increase with sales, not net income. Option C is incorrect as pro forma financial statements are used to forecast future performance, not assess historical performance. Option D is incorrect as the payout ratio is unrelated to a firm's capacity to generate additional funds for growth. Option E is incorrect as the projected balance sheet method is not specifically suited for lumpy assets or economies of scale.

Question 8

Other things held constant,which of the following statements is correct if a firm currently is operating at its financial breakeven point?
A) EBIT must be greater than zero.
B) EBIT would equal zero if the firm is financed only with common stock (i.e. ,there is no debt or preferred stock).
C) EBIT would equal zero,hence EPS would be less than zero,if the firm has preferred stock but no debt.
D) EPS would equal zero only if the firm is financed with some amount of debt.
E) The firm would not be considered to have much financial risk,especially when compared to a firm that operates well above its financial breakeven point.

Accepted Answer

At the financial breakeven point, EBIT is zero if the firm is financed only with common stock, as there are no fixed financial charges like interest or preferred dividends.

Question 9

Considering each action independently and holding other things constant,which of the following actions would reduce the firm's need for additional capital?
A) An increase in the dividend payout ratio.
B) A decrease in the profit margin.
C) A decrease in the days sales outstanding.
D) An increase in expected sales growth.
E) A decrease in the accrual accounts (accrued wages and taxes).

Accepted Answer

A decrease in the days sales outstanding means that the firm is collecting its receivables faster, which means it is receiving cash sooner and reducing the need for working capital or additional financing. The other options would either increase the need for capital (A, D) or have no direct impact on the need for capital (B, E).

Question 10

The degree of financial leverage for Aries Inc.is 3.0,and the degree of financial leverage for Common Capital Corporation is 6.2.According to this information,which firm is considered to have greater overall (total)risk?
A) Aries Inc.
B) Common Capital Corporation.
C) The degree of financial leverage is a measure of financial risk,so the only conclusion that can be made with the information given is that Common Capital Corporation has greater financial risk than Aries Inc.⎯ we cannot tell which firm has greater total risk.
D) To determine which firm has the greater total risk,we need to know the financial breakeven point of each firm.
E) None of the above is a correct answer.

Accepted Answer

The degree of financial leverage (DFL) measures a company's financial risk by showing how much its earnings per share (EPS) can change due to a change in operating income. A higher DFL indicates higher financial risk because it means the company's EPS is more sensitive to changes in operating income, due to a higher proportion of fixed financing costs (like interest on debt). However, total risk includes both financial risk and business (operating) risk. The information provided only allows us to compare the financial risk between Aries Inc. and Common Capital Corporation, not their total risk.

Question 11

Assume a portion of a firm's long-term funds includes either debt or preferred stock.Which of the following statements is correct?
A) The firm must possess operating leverage,which means that a change in net income will result in a greater percentage change in earnings before interest and taxes (EBIT).
B) The firm has financial leverage,which means that a change in sales will result in a greater percentage change in EBIT.
C) The firm has financial leverage,which means that a change in EBIT will result in a greater percentage change in earnings per share (EPS).
D) The firm doesn't have leverage,because leverage is created through the use of common equity financing only.
E) None of the above is a correct answer.

Accepted Answer

Financial leverage occurs when a firm uses debt or preferred stock in its capital structure. This leverage amplifies the effects of changes in EBIT on the firm's EPS, because fixed financing costs do not change with EBIT.

Question 12

Which of the following is a key determinant of operating leverage?
A) Level of debt.
B) Physical location of production facilities.
C) Cost of debt.
D) Technology.
E) Capital structure.

Accepted Answer

Technology is a key determinant of operating leverage because it affects the fixed and variable costs of production. A firm with high fixed costs and low variable costs is said to have high operating leverage, while a firm with low fixed costs and high variable costs is said to have low operating leverage. Technology influences the mix of fixed and variable costs in a firm's production process.

Question 13

Which of the following statements about cash management is false?
A) Depreciation expense does not appear explicitly on the cash budget,but its tax effects are included.
B) If cash flows are not uniform during the month,then weekly or perhaps daily cash budgets should be prepared rather than monthly budgets.
C) Compensating balance requirements do not affect a firm's target cash balance.
D) Cash management involves costs,and it is important to analyze whether the benefits received outweigh the costs included.
E) The cash budget is the foundation of good cash management.

Accepted Answer

Compensating balance requirements can affect a firm's target cash balance because they require a certain percentage of the firm's deposits to be held in a non-interest-bearing account with the bank. This reduces available funds for other uses and can affect the firm's cash management strategy.

Question 14

Which of the following statements is correct?
A) Any forecast of financial requirements involves determining how much money the firm will need and is obtained by adding together increases in assets and spontaneous liabilities and subtracting operating income.
B) The projected balance sheet method of forecasting financial needs requires only a forecast of the firm's balance sheet.Although a forecasted income statement helps clarify the financing needs,it is not essential to the balance sheet method.
C) Because dividends are paid after taxes from retained earnings,dividends are not included in the projected balance sheet method of forecasting.
D) The projected balance sheet method forces recognition of the fact that new financing creates additional financial obligations.For instance,new financing can increase expenses which can actually decrease taxes but increase the projected financial need.
E) Financing feedback describes the effect on the firm's stock price of the announcement that the firm will sell new equity or debt to raise needed capital.

Accepted Answer

The projected balance sheet method accounts for the fact that new financing can create additional financial obligations, which can affect expenses, taxes, and the overall projected financial need.

Question 15

The projected balance sheet method of forecasting is based on which of the following assumptions?
A) All balance sheet accounts are tied directly to sales.
B) Most balance sheet accounts are tied directly to sales.
C) The current level of total assets is optimal for the current sales level.
D) Answers a and c above.
E) Answers b and c above.

Accepted Answer

The projected balance sheet method assumes that the current level of total assets is optimal for the current sales level (option C) and that most balance sheet accounts are tied directly to sales (option B). Therefore, answer E, which includes both options B and C, is the best choice. Option A is incorrect because not all balance sheet accounts may be tied directly to sales. Option D is incorrect because option A is incorrect.

Question 16

The degree of financial leverage has which of the following characteristics?
A) The closer the firm is operating to its financial breakeven point,the smaller the DFL.
B) Other things held constant,if a firm has fixed financial costs,such as interest,a change in EBIT will result in an equivalent change in EPS.
C) For a particular firm,the DFL is not a fixed number⎯its value depends on the level of operations and the fixed financial costs associated with those operations.
D) The DFL relates the change in EBIT to the change in sales.
E) If a firm has common stock,it is impossible for its DFL to equal 1.0.

Accepted Answer

The degree of financial leverage (DFL) is not a fixed number; it varies depending on the level of operations and the fixed financial costs. It measures how sensitive the firm's earnings per share (EPS) are to changes in its operating income (EBIT).

Question 17

The financial breakeven point for a firm is defined as the level of ____ that produces ____ equal to zero.
A) sales;EBIT.
B) sales;gross profit.
C) EPS;sales.
D) gross profit;EBIT.
E) EBIT;EPS.

Accepted Answer

The financial breakeven point is when the Earnings Before Interest and Taxes (EBIT) results in Earnings Per Share (EPS) being zero, indicating no profit or loss for shareholders.

Question 18

The degree of operating leverage has which of the following characteristics?
A) The closer the firm is operating to breakeven quantity,the smaller the DOL.
B) A change in quantity demanded will produce the same percentage change in EBIT as an identical change in price per unit of output,other things held constant.
C) The DOL is not a fixed number for a given firm,but will depend upon the time zero values of the economic variables Q (Quantity),P (Price),and V (Volume).
D) The DOL relates the change in net income to the change in net operating income.
E) If the firm has no debt,the DOL will equal 1.

Accepted Answer

EThe Degree of Operating Leverage (DOL) depends on the firm's cost structure and sales volume, not fixed for a given firm as it varies with changes in quantity, price, and volume. If a firm has no debt, its financial leverage is zero, but its operating leverage can still exist due to fixed operational costs, making E incorrect because DOL can be different from 1 even without debt, as it measures the sensitivity of operating income to changes in sales volume, not the presence of debt.

Question 19

Which of the following is (are)typically part of the cash budget?
A) Payments lag.
B) Payment for plant construction.
C) Cumulative cash.
D) All of the above.
E) Only answers a and c above.

Accepted Answer

A cash budget typically includes all aspects of cash inflows and outflows, including payments lag, payment for plant construction, and cumulative cash, to provide a comprehensive view of an organization's cash position.

Question 20

Which of the following statements is correct?
A) The first pass using the projected balance sheet method determines the financing feedback effects and determines how much in additional funds are needed.The second pass completes the cycle,identifies the full financing need,and eliminates further feedback effects.
B) Interest expense on additional new debt is the only income statement account affected by financing feedback,and dividends payable to new common stock is the only balance sheet account affected.
C) The projected balance sheet method is useful for determining additional funds needed,however,it cannot be used in evaluating dividend policy and capital structure decisions.
D) One reason a firm's managers may choose to meet additional funds needed requirements through common stock is that it involves no financing feedback effects.Since no new debt is used,interest expense will be considered fully in the first pass,the income statement will remain unchanged,and no second pass is needed.
E) If new debt and new stock are used to meet new financing needs,net income will decrease from the first pass to the second pass even though taxes decrease.In addition,if dividends are to be paid on new stock,this will further decrease the amount of retained earnings available for financing needs.

Accepted Answer

The answer of Which of the following statements is correct?
A)...

Quiz 8: Financial Planning and Control

Holding other things constant,the additional funds required for financing the firm's operations would be reduced with an increase in the firm's

The projected balance sheet forecasting method produces accurate results unless which of the following condition(s) is (are) present?

If a firm's degree of total leverage (DTL) is 8.0,which of the following must be correct?

Which of the following is a key determinant of financial leverage?

The degree of operating leverage for ABC Inc.is 3.5,and the degree of operating leverage for XYZ Corporation is 7.0.According to this information,which firm is considered to have greater business risk?

The degree of financial leverage for ABC Inc.is 2.5,and the degree of financial leverage for XYZ Corporation is 1.5.According to this information,which firm is considered to have greater financial risk?

Which of the following statements is correct?

Other things held constant,which of the following statements is correct if a firm currently is operating at its financial breakeven point?

Considering each action independently and holding other things constant,which of the following actions would reduce the firm's need for additional capital?

The degree of financial leverage for Aries Inc.is 3.0,and the degree of financial leverage for Common Capital Corporation is 6.2.According to this information,which firm is considered to have greater overall (total) risk?

Assume a portion of a firm's long-term funds includes either debt or preferred stock.Which of the following statements is correct?

Which of the following is a key determinant of operating leverage?

Which of the following statements about cash management is false?

Which of the following statements is correct?

The projected balance sheet method of forecasting is based on which of the following assumptions?

The degree of financial leverage has which of the following characteristics?

The financial breakeven point for a firm is defined as the level of that produces equal to zero.

The degree of operating leverage has which of the following characteristics?

Which of the following is (are) typically part of the cash budget?

Which of the following statements is correct?