Chapter 03 - Financial Forecasting

Chapter 03
Financial Forecasting
 

Multiple Choice Questions

 

1. You are estimating your company's external financing needs for the next year. At the end of
the year you expect that owners' equity will be $80 million, total assets will amount to $170
million, and total liabilities will be $70 million. How much will your firm need to borrow, or
otherwise acquire, from outside sources during the year? 
A. $20 million
B. $70 million
C. $150 million
D. $160 million
E. $180 million
F. None of the above.

2. To estimate Missed Places, Inc.'s (MP) external financing needs, the CFO needs to figure
out how much equity her firm will have at the end of next year. At the end of the most recent
fiscal year, MP's retained earnings were $158,000. The Controller has estimated that over the
next year, gross profits will be $360,700, earnings after tax will total $23,400, and MP will
pay $12,400 in dividends. What are the estimated retained earnings at the end of next year? 
A. $169,000
B. $170,400
C. $181,400
D. $506,300
E. $518,700
F. None of the above.

3. The most common approach to developing proforma financial statements is called the: 
A. cash budget method.
B. financial planning method.
C. seasonality approach.
D. percent-of-sales method.
E. market-oriented approach.
F. None of the above.

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4. Which of the following are viable techniques to cope with the uncertainty inherent in
realistic financial projections?

I. Simulation
II. Ad hoc adjustments
III. Scenario analysis
IV. Sensitivity analysis 
A. II and IV only
B. III and IV only
C. II, III, and IV only
D. I, II, and III only
E. I, III, and IV only
F. I, II, III, and IV

5. Which one of the following statements is correct concerning the cash balance of a firm? 
A. Most firms attempt to maintain a zero cash balance at all times.
B. The cumulative cash surplus shown on a cash budget is equal to the ending cash balance
plus the minimum desired cash balance.
C. Most firms attempt to maximize the cash balance at all times.
D. A cumulative cash deficit indicates a borrowing need.
E. The ending cash balance must equal the minimum desired cash balance.

6. Assume each month has 30 days and AmDocs has a 60-day accounts receivable period.
During the second calendar quarter of the year (April, May and June), AmDocs will collect
payment for the sales it made during which of the months listed below? 
A. October, November, and December
B. November, December, and January
C. December, January, and February
D. January, February, and March
E. February, March, and April

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7. The Limited collects 25 percent of sales in the month of sale, 60 percent of sales in the
month following the month of sale, and 15 percent of sales in the second month following the
month of sale. During the month of April, the firm will collect: 
A. 60 percent of February sales.
B. 15 percent of April sales.
C. 60 percent of March sales.
D. 15 percent of March sales.
E. 25 percent of February sales.

8. Steve has estimated the cash inflows and outflows for his sporting goods store for next
year. The report that he has prepared summarizing these cash flows is called a: 
A. pro forma income statement.
B. sales projection.
C. cash budget.
D. receivables analysis.
E. credit analysis.
F. None of the above.

9. You are developing a financial plan for a corporation. Which of the following questions
will be considered as you develop this plan?

I. How much will our sales grow?

II. Will additional fixed assets be required?
III. Will dividends be paid to shareholders?
IV. How much new debt must be obtained? 
A. I and IV only
B. II and III only
C. I, III, and IV only
D. II, III, and IV only
E. I, II, III, and IV

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10. Financial planning: 
A. focuses solely on the short-term outlook for a firm.
B. is a process that firms employ only when major changes to a firm's operations are
anticipated.
C. is a process that firms undergo once every five years.
D. considers multiple options and scenarios for the next two to five years.
E. provides minimal benefits for firms that are highly responsive to economic changes.

11. Ruff Wear expects sales of $560, $650, $670, and $610 for the months of May through
August, respectively. The firm collects 20 percent of sales in the month of sale, 70 percent in
the month following the month of sale, and 8 percent in the second month following the
month of sale. The remaining 2 percent of sales is never collected. How much money does the
firm expect to collect in the month of August? 
A. $621
B. $628
C. $633
D. $639
E. $643

12. On May 1, Vaya Corp. had a beginning cash balance of $175. Vaya's sales for April were
$430 and May sales were $480. During May, the firm had cash expenses of $110 and made
payments on accounts payable of $290. Vaya's accounts receivable period is 30 days. What is
the firm's beginning cash balance on June 1? 
A. $145
B. $155
C. $205
D. $215
E. $265

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13. Please refer to Oscar's financial statements. What was the increase in retained earnings of
Oscar's during 2012? 
A. $450
B. $1,380
C. $1,830
D. $2,280
E. None of the above.

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Chapter 03 - Financial Forecasting

14. Please refer to Oscar's financial statements. Sales are projected to increase by 3 percent
next year. The profit margin and the dividend payout ratio are projected to remain constant.
What is the projected addition to retained earnings for next year? 
A. $1,309.19
B. $1,421.40
C. $1,884.90
D. $2,667.78
E. $3,001.40
F. None of the above.

15. Please refer to Oscar's financial statements. All of Oscar's costs and net working capital
vary directly with sales. Sales are projected to increase by 10 percent. What is the pro forma
accounts receivable balance for next year? 
A. $949
B. $1,034
C. $1,113
D. $1,730
E. $2,670
F. None of the above.

16. Please refer to Oscar's financial statements. Assume a constant net profit margin and
dividend payout ratio, and further assume all of Oscar's assets and current liabilities vary
directly with sales. Assume long-term debt and common stock remain unchanged. Sales are
projected to increase by 10 percent. What is the external financing need for next year? 
A. -$410
B. -$260
C. $235
D. $1,320
E. $7,240
F. None of the above.

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17. Please refer to Oscar's financial statements. Assume a constant debt-equity ratio, net profit
margin and dividend payout ratio, and further assume all of Oscar's costs, assets and current
liabilities vary directly with sales. What is the pro forma net fixed asset value for next year if
sales are projected to increase by 7.5 percent? 
A. $10,857.50
B. $10,931.38
C. $11,663.75
D. $15,587.50
E. $18,987.50
F. None of the above.

 
 

Short Answer Questions

 

18. Pro forma financial statements, by definition, are predictions of a company's financial

statements at a future point in time. So, why is it important to analyze the historical
performance of the company before constructing pro forma financial statements? 

 
 

19. Edna's Laundry Services just completed pro forma statements using the percentage of
sales approach. The pro forma shows a projected external financing need of -$5,500. Interpret
this figure. What are the firm's options in this case? 

 
 

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Chapter 03 - Financial Forecasting

20. Preston Fencing Company's sales, half of which are for cash and the other half sold on
credit, over the past three months were:

a. Estimate Preston's cash receipts in October if the company's collection period is 30 days.
b. Estimate Preston's cash receipts in October if the company's collection period is 45 days.
c. What would be the October balance of accounts receivable for Preston Fencing if the
company's collection period is 30 days? 45 days? 

 
 

21. Suppose your colleague constructed a pro forma balance sheet and a cash budget for your
company for the same time period, and the external financing required from the pro forma
forecast exceeded the cash deficit estimated on the cash budget. How would you interpret this
result? 

 
 

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Chapter 03 Financial Forecasting Answer Key

 

Multiple Choice Questions

 

1. You are estimating your company's external financing needs for the next year. At the end of
the year you expect that owners' equity will be $80 million, total assets will amount to $170
million, and total liabilities will be $70 million. How much will your firm need to borrow, or
otherwise acquire, from outside sources during the year? 
A. $20 million
B. $70 million
C. $150 million
D. $160 million
E. $180 million
F. None of the above.

Difficulty: 1 Easy
 

2. To estimate Missed Places, Inc.'s (MP) external financing needs, the CFO needs to figure
out how much equity her firm will have at the end of next year. At the end of the most recent
fiscal year, MP's retained earnings were $158,000. The Controller has estimated that over the
next year, gross profits will be $360,700, earnings after tax will total $23,400, and MP will
pay $12,400 in dividends. What are the estimated retained earnings at the end of next year? 
A. $169,000
B. $170,400
C. $181,400
D. $506,300
E. $518,700
F. None of the above.

Difficulty: 1 Easy
 

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3. The most common approach to developing proforma financial statements is called the: 
A. cash budget method.
B. financial planning method.
C. seasonality approach.
D. percent-of-sales method.
E. market-oriented approach.
F. None of the above.

Difficulty: 1 Easy
 

4. Which of the following are viable techniques to cope with the uncertainty inherent in
realistic financial projections?

I. Simulation
II. Ad hoc adjustments
III. Scenario analysis
IV. Sensitivity analysis 
A. II and IV only
B. III and IV only
C. II, III, and IV only
D. I, II, and III only
E. I, III, and IV only
F. I, II, III, and IV

Difficulty: 2 Medium
 

5. Which one of the following statements is correct concerning the cash balance of a firm? 
A. Most firms attempt to maintain a zero cash balance at all times.
B. The cumulative cash surplus shown on a cash budget is equal to the ending cash balance
plus the minimum desired cash balance.
C. Most firms attempt to maximize the cash balance at all times.
D. A cumulative cash deficit indicates a borrowing need.
E. The ending cash balance must equal the minimum desired cash balance.

Difficulty: 1 Easy
 

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Chapter 03 - Financial Forecasting

6. Assume each month has 30 days and AmDocs has a 60-day accounts receivable period.
During the second calendar quarter of the year (April, May and June), AmDocs will collect
payment for the sales it made during which of the months listed below? 
A. October, November, and December
B. November, December, and January
C. December, January, and February
D. January, February, and March
E. February, March, and April

Difficulty: 1 Easy
 

7. The Limited collects 25 percent of sales in the month of sale, 60 percent of sales in the
month following the month of sale, and 15 percent of sales in the second month following the
month of sale. During the month of April, the firm will collect: 
A. 60 percent of February sales.
B. 15 percent of April sales.
C. 60 percent of March sales.
D. 15 percent of March sales.
E. 25 percent of February sales.

Difficulty: 1 Easy
 

8. Steve has estimated the cash inflows and outflows for his sporting goods store for next
year. The report that he has prepared summarizing these cash flows is called a: 
A. pro forma income statement.
B. sales projection.
C. cash budget.
D. receivables analysis.
E. credit analysis.
F. None of the above.

Difficulty: 1 Easy
 

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Chapter 03 - Financial Forecasting

9. You are developing a financial plan for a corporation. Which of the following questions
will be considered as you develop this plan?

I. How much will our sales grow?

II. Will additional fixed assets be required?
III. Will dividends be paid to shareholders?
IV. How much new debt must be obtained? 
A. I and IV only
B. II and III only
C. I, III, and IV only
D. II, III, and IV only
E. I, II, III, and IV

Difficulty: 1 Easy
 

10. Financial planning: 
A. focuses solely on the short-term outlook for a firm.
B. is a process that firms employ only when major changes to a firm's operations are
anticipated.
C. is a process that firms undergo once every five years.
D. considers multiple options and scenarios for the next two to five years.
E. provides minimal benefits for firms that are highly responsive to economic changes.

Difficulty: 1 Easy
 

11. Ruff Wear expects sales of $560, $650, $670, and $610 for the months of May through
August, respectively. The firm collects 20 percent of sales in the month of sale, 70 percent in
the month following the month of sale, and 8 percent in the second month following the
month of sale. The remaining 2 percent of sales is never collected. How much money does the
firm expect to collect in the month of August? 
A. $621
B. $628
C. $633
D. $639
E. $643

August collections = 0.20($610) + 0.70($670) + 0.08($650) = $643

Difficulty: 1 Easy
 

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12. On May 1, Vaya Corp. had a beginning cash balance of $175. Vaya's sales for April were
$430 and May sales were $480. During May, the firm had cash expenses of $110 and made
payments on accounts payable of $290. Vaya's accounts receivable period is 30 days. What is
the firm's beginning cash balance on June 1? 
A. $145
B. $155
C. $205
D. $215
E. $265

Cash balance = $175 - $110 - $290 + $430 = $205

Difficulty: 1 Easy
 

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13. Please refer to Oscar's financial statements. What was the increase in retained earnings of
Oscar's during 2012? 
A. $450
B. $1,380
C. $1,830
D. $2,280
E. None of the above.

Difficulty: 1 Easy
 

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14. Please refer to Oscar's financial statements. Sales are projected to increase by 3 percent
next year. The profit margin and the dividend payout ratio are projected to remain constant.
What is the projected addition to retained earnings for next year? 
A. $1,309.19
B. $1,421.40
C. $1,884.90
D. $2,667.78
E. $3,001.40
F. None of the above.

Projected addition to retained earnings = $1,380  (1 + .03) = $1,421.40

Difficulty: 1 Easy
 

15. Please refer to Oscar's financial statements. All of Oscar's costs and net working capital
vary directly with sales. Sales are projected to increase by 10 percent. What is the pro forma
accounts receivable balance for next year? 
A. $949
B. $1,034
C. $1,113
D. $1,730
E. $2,670
F. None of the above.

Proforma accounts receivable = $940  (1 + .10) = $1,034

Difficulty: 1 Easy
 

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16. Please refer to Oscar's financial statements. Assume a constant net profit margin and
dividend payout ratio, and further assume all of Oscar's assets and current liabilities vary
directly with sales. Assume long-term debt and common stock remain unchanged. Sales are
projected to increase by 10 percent. What is the external financing need for next year? 
A. -$410
B. -$260
C. $235
D. $1,320
E. $7,240
F. None of the above.

Projected total assets = $14500 *1.10 = $15950

Projected total liabilities = $1920*1.10 + $3500 = $5612
Projected total equity = $7500 + [$1580 + $1830*1.10 - $450*1.1] = $10598
External financing needed = $15950 - ($5612 + $10598) = -$260

Difficulty: 2 Medium
 

17. Please refer to Oscar's financial statements. Assume a constant debt-equity ratio, net profit
margin and dividend payout ratio, and further assume all of Oscar's costs, assets and current
liabilities vary directly with sales. What is the pro forma net fixed asset value for next year if
sales are projected to increase by 7.5 percent? 
A. $10,857.50
B. $10,931.38
C. $11,663.75
D. $15,587.50
E. $18,987.50
F. None of the above.

Proforma net fixed assets = $10850 * (1 + 0.075) = $11,663.75

Difficulty: 2 Medium
 
 

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Short Answer Questions

 

18. Pro forma financial statements, by definition, are predictions of a company's financial

statements at a future point in time. So, why is it important to analyze the historical
performance of the company before constructing pro forma financial statements? 

Historical analysis helps decide for which financial statement items a percent-of-sales forecast
might be appropriate. For example, a stable trend in the collection period would tell you that,
unless you expect changes in the management of the accounts receivable, future collection
periods should continue along this trend.

Difficulty: 2 Medium
 

19. Edna's Laundry Services just completed pro forma statements using the percentage of
sales approach. The pro forma shows a projected external financing need of -$5,500. Interpret
this figure. What are the firm's options in this case? 

A negative value implies that the company has excess cash above its desired minimum. With
a negative external financing need, the firm has a surplus of funds that it can use to reduce
current liabilities, reduce long-term debt, buy back common stock, or increase dividends. If
acceptable opportunities exist, the firm might also use the extra funds to purchase fixed assets,
thereby increasing its potential growth, should that action be warranted.

Difficulty: 2 Medium
 

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20. Preston Fencing Company's sales, half of which are for cash and the other half sold on
credit, over the past three months were:

a. Estimate Preston's cash receipts in October if the company's collection period is 30 days.
b. Estimate Preston's cash receipts in October if the company's collection period is 45 days.
c. What would be the October balance of accounts receivable for Preston Fencing if the
company's collection period is 30 days? 45 days? 

a. If the collection period is 30 days, October cash receipts from September sales will equal
half of September sales or $60,000. In addition, the company will receive cash from half of
October sales, which were for cash of $40,000. The total is $100,000.
b. With a 45-day collection period, cash collected during the first half of October is from
credit sales made from the middle until the end of August; and collections during the second
half of October are from credit sales made from the beginning until the middle of September.
Therefore, cash receipts from credit sales (which are half of total sales) are from the period
mid-August through mid-September, or (70,000/2 + 120,000/2)/2 = $47,500. Adding sales for
cash of $40,000 in October, the total is $87,500.
c. If the collection period is 30 days, then the October accounts receivable balance should be
the last 30 days' worth of credit sales. October credit sales were $40,000, thus the accounts
receivable balance would be $40,000. If the collection period is 45 days, then the balance
would be October's credit sales and half of September's credit sales, or 40,000 + 60,000/2 =
$70,000.

Difficulty: 2 Medium
 

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21. Suppose your colleague constructed a pro forma balance sheet and a cash budget for your
company for the same time period, and the external financing required from the pro forma
forecast exceeded the cash deficit estimated on the cash budget. How would you interpret this
result? 

This would tell you that your colleague had erred in constructing one or both of the forecasts.
Using the same assumptions and avoiding accounting and arithmetic errors, estimated
external financing required should equal estimated cash surplus or deficit for the same date.

Difficulty: 1 Easy
 

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