UTD Mace FIN 3320 Ch 16

In the control phase of the financial planning process, projected financial statements must be evaluated to determine _____.

whether the forecasts meet the firm's financial targets

Expert Analysts Resources (EAR) has provided you with the following information about three companies you are currently evaluating:

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Company Degree of Operating Leverage (DOL) Degree of Financial Leverage (DFL)

Acme 1.5× 6.0×

Apex 3.0× 4.0×

Alps 5.0× 2.0×

Apex, because it has the highest degree of total leverage (DTL)

DOL x DFL = DTL

Compuvac Company just completed its initial forecasts of next year's financial statements using the projected balance sheet method. The firm determined that it needs $4 million in new debt, which can be issued at par with a 10 percent annual coupon. Additionally, the firm can sell 500,000 shares of new common equity, which will net $18.10 per share. Next year's expected dividend is $0.48 per share. After accounting for the financing feedbacks associated with raising the required funds, Compuvac expects its taxes to be $160,000 lower than were reported in the initial forecasts. Given this information, what should Compuvac find the change to be in the addition to retained earnings that is reported in the income statement that was initially forecasted after the financing feedbacks are included?

-$480,000

Which of the following statements concerning the financial breakeven point, EBITFinBEP, is correct?

a. The financial breakeven point determines the level of sales a new product must achieve to be profitable.

b. The financial breakeven point analyzes the consequences of purchasing modernization projects that require increase investments in fixed assets.

c. The financial breakeven point determines the impact of a firm's financing mix on its earnings per share (EPS).

d. The financial breakeven point represents the level of production and sales at which net operating income equals zero.

e. The financial breakeven point determines the effects of a general expansion in the level of a firm's operations.

The financial breakeven point determines the impact of a firm's financing mix on its earnings per share (EPS).

Everything else equal, a firm can reduce its operating breakeven point by _____.

increasing its product's contribution margin

Which of the following mathematical expressions is used to compute the degree of financial leverage (DFL) at a particular level of earnings before interest and taxes (EBIT)? Assume the firm has no preferred stock.

a. DFL = Earnings before interest and taxes ÷ (Earnings before interest and taxes - Interest)

b. DFL = Gross profit ÷ Earnings before interest and taxes

c. DFL = (Earnings before interest and taxes - Interest - Taxes) ÷ Number of shares

d. DFL = Earnings before interest and taxes ÷ Earnings per share (EPS)

e. DFL = Sales ÷ (Earnings before interest and taxes - Interest)

DELETE

If a firm currently operates at less than full capacity, it must increase existing plant and equipment only if _____.

the unused capacity of its existing assets is not sufficient to support a forecasted increase in sales

Considering each item independently and holding other things constant, which of the following actions would reduce a firm's need for additional capital (additional funds needed, AFN)?

a. Decrease the firm's days sales outstanding (DSO)

b. Decrease the firm's profit margin

c. Increase the firm's expected sales growth

d. Decrease the firm's accrual accounts (e.g., accrued wages and taxes)

e. Increase the firm's dividend payout ratio

Decrease the firm's days sales outstanding (DSO)

Which of the following statements concerning lumpy assets is correct?

a. Lumpy assets can be acquired in small increments.

b. Lumpy assets generally have lives that are less than 12 months.

c. Lumpy assets normally are extremely liquid.

d. Purchasing lumpy assets generally does not have a significant effect on the amount of fixed assets a firm holds.

e. If it can only purchase lumpy assets, it is possible that a firm will be required to invest a substantial amount in plant and equipment to attain a small projected increase in sales.

e. If it can only purchase lumpy assets, it is possible that a firm will be required to invest a substantial amount in plant and equipment to attain a small projected increase in sales.

On-The-Go Merchandiser sells luxury carry-on travel bags for $1,200 each. The firm's fixed operating costs are $600,000 when 5,000 or fewer bags are produced, and its variable cost ratio is 80 percent (i.e., variable cost per unit is 80 percent of the selling price). What is On-The-Go's operating breakeven point?

2,500 bags

Marcus Corporation currently sells 150,000 units per year at a price of $4.00 a unit. Its variable costs are 30 percent of sales, and its fixed operating costs are $300,000. What is Marcus's degree of operating leverage (DOL) at sales equal to 150,000 units?

3.5×

(DOL) = Gross profit/EBIT = [(150,000 units × $4) - (0.30 × $150,000 units × $4)]/[(150,000 units × $4) - (0.30 × $150,000 units × $4) - $300,000] = ($600,000 − $180,000)/($600,000 − $180,000 − $300,000) = $420,000/$120,000 = 3.5×

Trident Food Corporation generated the following income statement for the most recent fiscal year:

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Sales revenues $ 150,000

Variable cost of sales (120,000)

Gross profit 30,000

Fixed operating costs (10,000)

Net operating income (EBIT) $ 20,000

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What is the degree of operating leverage (DOL) for Trident Food?

1.5x

The financial breakeven point is the level of _____ at which earnings per share (EPS) is equal to zero.

net operating income (NOI)

If a firm that has a degree of operating leverage (DOL) greater than 1.0 experiences a 1.0 percent change in _____, its earnings before interest and taxes (EBIT) will change by _____1.0 percent.

sales; greater than

Which of the following statements about the financial planning process is correct?

a. The projected balance sheet method of forecasting financial needs does not consider dividends paid to shareholders because these are after tax payments from retained earnings.

b. Financial forecasts generally do not consider forecasts of the economic prospects for the nation and the industry because these are factors that are beyond the control of the firm.

c. The additional funds needed (AFN) is estimated by summing the expected changes in assets and liabilities that fluctuate with sales and then subtracting the expected operating income.

e. The decision as to how a firm should raise additional funds needed (AFN) to meet its financial goals depends on the ability of the firm to handle additional debt, conditions in financial markets, and restrictions imposed by existing debt agreements.

e. The decision as to how a firm should raise additional funds needed (AFN) to meet its financial goals depends on the ability of the firm to handle additional debt, conditions in financial markets, and restrictions imposed by existing debt agreements.

EvenFlo Pipes forecasts a small increase in sales next year. To achieve this growth in sales, however, the firm must purchase an amount of plant and equipment that is more than double the increase in sales. What is the most likely reason EvenFlo must purchase such a large amount of fixed assets?

The firm must purchase lumpy assets to achieve the increase in sales.

Which of the following mathematical expressions is used to compute the degree of financial leverage (DFL) at a particular level of earnings before interest and taxes (EBIT)? Assume the firm has no preferred stock.

a. DFL = Sales ÷ (Earnings before interest and taxes - Interest)

b. DFL = (Earnings before interest and taxes - Interest - Taxes) ÷ Number of shares

c. DFL = Gross profit ÷ Earnings before interest and taxes

d. DFL = Earnings before interest and taxes ÷ (Earnings before interest and taxes - Interest)

e. DFL = Earnings before interest and taxes ÷ Earnings per share (EPS)

d. DFL = Earnings before interest and taxes ÷ (Earnings before interest and taxes - Interest)

EBIT/(EBIT-Interest)

Operating breakeven analysis deals with the _____.

revenues and expenses associated with a firm's normal production and selling operations

To produce sales of $4,500,000, Azure Inc. uses only 80 percent of its plant capacity. Therefore, Azure can increase its sales to _____ without having to increase its plant and equipment.

$5,625,000

Full-capacity sales = Existing sales level ÷ Percent of capacity used to generate existing sales level

Full-capacity sales = $4,500,000/80% = $5,625,000

Which of the following statements about funds that a firm generates spontaneously (internally) is correct?

a. Spontaneously generated funds are funds that a firm must raise by issuing new stocks and new bonds.

b. Current liabilities that provide spontaneously generated funds require the firm's management to make conscious financing decisions.

c. In general, current liabilities that change naturally with changes in sales provide spontaneously generated funds.

d. Spontaneously generated funds tend to change at the same rate as a change in the firm's net operating income.

e. Notes payable, long-term bonds, and common stock provide most of the firm's spontaneously generated funds.

c. In general, current liabilities that change naturally with changes in sales provide spontaneously generated funds.

Citation Manufacturing produces electronic components that sell for $600 each. The fixed production costs are $720,000 when 30,000 or fewer components are produced, and variable production costs are $510 per component. What is Citation's operating breakeven point?

8,000 components

QOpBE = (Fixed operating costs)/(Product selling price - Variable operating costs) = $720,000/($600 - $510) = 8,000

Following is the balance sheet of Cyan Inc.:

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Current assets $ 5,000 Accounts payable $ 1,000

Net fixed assets 10,000 Accruals 1,000

Long-term debt 5,000

Common equity 8,000

Total $15,000 Total $15,000

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Cyan currently is operating at full capacity. Next year, the firm expects sales to increase by 50 percent. It also expects to retain $2,000 of next year's earnings to invest in additional fixed assets. What will be Cyan's additional funds needed (AFN) next year?

$4,500

apply increases

TA - TL

22500-1800 = 4500

______ are assets that must be purchased in large, discrete units.

Lumpy assets

The additional funds needed (AFN) to achieve a particular growth in sales will be negative if _____.

the amount of internally generated funds is more than sufficient to support the forecasted increase in sales

A firm examines the relationship between its sales volume and its operating profitability by conducting a(n) _____ analysis.

operating breakeven (cost-volume-profit)

When economies of scale exist, a firm's _____ ratio is likely to decrease if the size of the firm increases substantially.

variable cost of goods sold

Suppose that in the control phase of the financial planning process a firm discovers it cannot raise the funds that are required to meet the forecasted sales. In this situation, the firm should ______.

scale back its projected level of operations

Which of the following mathematical equations is used to calculate the degree of operating leverage (DOL)? (Δ = change)

a. DOL = % Δ in sales/% Δ in earnings per share (EPS)

b. DOL = % Δ in sales/% Δ in earnings before taxes (EBT)

c. DOL = % Δ in earnings per share (EPS)/% Δ in earnings before taxes (EBT)

d. DOL = % Δ in net operating income (NOI)/% Δ in sales

e. DOL = % Δ in earnings before interest and taxes (EBIT)/% Δ in earnings per share (EPS)

d. DOL = % Δ in net operating income (NOI)/% Δ in sales

Current liabilities accounts that change "naturally" with changes in sales provide funds that tend to change at the same rate as sales. These funds are referred to as ______ funds.

spontaneously generated

The ______ forecast is the most important ingredient of the financial forecasting process. If this forecast is inaccurate, the consequences to the forecasting firm can be serious.

sales

Which of the following statements about funds that a firm generates spontaneously (internally) is correct?

a. In general, current liabilities that change naturally with changes in sales provide spontaneously generated funds.

b. Spontaneously generated funds are funds that a firm must raise by issuing new stocks and new bonds.

c. Spontaneously generated funds tend to change at the same rate as a change in the firm's net operating income.

d. Notes payable, long-term bonds, and common stock provide most of the firm's spontaneously generated funds.

e. Current liabilities that provide spontaneously generated funds require the firm's management to make conscious financing decisions.

a. In general, current liabilities that change naturally with changes in sales provide spontaneously generated funds.

Progressive Products makes coolers that sell for $250 each; the fixed production costs are $30,000 when 1,000 or fewer coolers are produced; and variable production costs are $200 per cooler. To the nearest dollar, what is the Progressive's current operating breakeven point?

$150,000

OPBE = F/P-V

=$30000/($250-$200)

=600u

=600u*$250 = $150,000

Suppose a firm's degree of financial leverage (DFL) is 1.0. Which of the following statements concerning this firm is correct?

a. The firm has no long-term debt, preferred stock, or other sources of financing that require fixed payments.

b. The firm's degree of operating leverage (DOL) must be greater than 1.0.

c. The firm's degree of total leverage (DTL) must equal 1.0.

d. The firm must have fixed costs associated with its production process.

e. The firm's earnings per share (EPS) must equal zero.

a. The firm has no long-term debt, preferred stock, or other sources of financing that require fixed payments.

Which of the following actions can be taken to reduce the firm's average collection period?

a. Decrease the firm's credit purchases

b. Revise the firm's capital budgeting investment policy

c. More aggressively collect delinquent credit accounts

d. Increase the firm's credit sales

e. Change the firm's inventory valuation method

More aggressively collect delinquent credit accounts

A firm would conduct operating breakeven analysis primarily to determine the _____.

level of sales a new product must achieve to be profitable

Which of the following account balances generally will not change when sales change?

a. Notes payable

b. Accounts payable

c. Accounts receivable

d. Accrued wages

e. Inventory level

Notes payable

In the financial control phase of the financial planning process, a firm is primarily concerned with _____.

implementing financial plans and dealing with the feedback and the adjustments needed to meet its goals

In which of the following situations will Firm A require greater amounts of external funding (additional funds needed, AFN) to meet its forecasted growth than Firm B? Assume the firms are identical in every other way.

a. Firm A has attained substantial economies of scale, whereas Firm B has not.

b. Firm A operates at full capacity, whereas Firm B does not.

c. Firm A generates substantial amounts of spontaneously generated funds, whereas Firm B generates very little.

d. Firm A operates close to its operating breakeven point, whereas Firm B operates well above its operating breakeven point.

e. Firm A uses the projected balance sheet method to forecast its pro forms financial statements, whereas Firm B does not.

b. Firm A operates at full capacity, whereas Firm B does not.

The degree of financial leverage (DFL) is defined as the percentage change in _____ that results from a given percentage change in earnings before interest and taxes (EBIT).

earnings per share (EPS)

Which of the following statements about operating breakeven analysis is correct?

a. Operating breakeven analysis involves determining the operating income the firm needs to generate to cover all of its financing costs.

b. Operating breakeven analysis involves the analysis of the interest payments to bondholders and the dividend payments to preferred stockholders.

c. Operating breakeven analysis involves determining the level of production and sales at which net operating income is equal to one.

d. Operating breakeven analysis involves determining the level of production and sales at which financing costs are recovered.

e. Operating breakeven analysis involves determining the point at which sales revenues equal operating costs.

e.

Operating breakeven analysis involves determining the point at which sales revenues equal operating costs.

By definition, a firm's financial breakeven point represents the level of net operating income (NOI) at which its _____.

earnings per share (EPS) is equal to zero

Which of the following statements about the degree of operating leverage (DOL) is correct?

The higher the DOL, the closer the firm is to its operating breakeven point.

Trident Food Corporation generated the following income statement for the most recent fiscal year:

Sales revenues $ 150,000

Variable cost of sales (120,000)

Gross profit 30,000

Fixed operating costs (10,000)

Net operating income (EBIT) 20,000

Interest (15,000)

Earnings before taxes 5,000

Taxes (40%) (2,000)

Net income $ 3,000

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What is Trident Food's degree of total leverage (DTL)?

6.0×

DFL = EBIT/EBIT-I

=20,000/20,000-15,000

=20,000/5,000

=4

DOL = 1.5x

4 * 1.5x = 6

Suppose a firm increases its sales using existing fixed assets. Everything else equal, what effect will the increase in sales have on the firm's degree of operating leverage (DOL)?

The DOL should decrease.

Based on its existing sales, what is the formula for calculating the full-capacity sales of a firm?

Full-capacity sales = Existing sales level ÷ Percent of capacity used to generate existing sales level

Which of the following statements concerning the degree of total leverage (DTL) is correct?

a. It is the level of earnings before interest and taxes (EBIT) at which earnings per share (EPS) equals zero.

b. DTL represents the level of production and sales at which net operating income is zero.

c. DTL is the percentage change in earnings per share (EPS) that results from a given percentage change in earnings before interest and taxes (EBIT).

d. DTL is the percentage change in earnings per share (EPS) that results from a 1 percent change in sales.

e. DTL is the percentage change in net operating income (NOI) (earnings before interest and taxes) associated with a given percentage change in sales.

d. DTL is the percentage change in earnings per share (EPS) that results from a 1 percent change in sales.

Which of the following is the first step involved in constructing pro forma financial statements?

a. Determining the additional funds needed (AFN) to support expected growth

b. Computing the firm's operating breakeven point

c. Determining financing feedbacks

d. Forecasting the next period's balance sheet

e. Forecasting the income statement

e.

Forecasting the income statement

By performing a cost-volume-profit analysis, EZ Rentals discovered that its operating breakeven point, QOpBEP, is at sales equal to $180,000. If EZ wants to decrease its operating breakeven point, which of the following actions should be taken? Assume everything else is equal.

a. Decrease sales

b. Decrease fixed financial costs

c. Increase fixed operating costs

d. Increase the variable operating cost ratio

e. Increase the product's contribution margin

e.

Increase the product's contribution margin

Which of the following would be considered part of financing feedbacks in the financial forecasting process?

a.The effects on the income statement and balance sheet of actions the firm takes to finance forecasted increases in assets.

b.The change in current assets that occur when a firm implements a sales forecast.

c.The effect that forecasted sales has on the owners of the firm.

d.The effects forecasts of the economic prospects for the nation, region, and industry have on the taxes the firm must pay on the income it earned in the most recent accounting period.

e.Funds that a firm must raise externally through new borrowing or by selling new stock to meet its financial goals.

a. The effects on the income statement and balance sheet of actions the firm takes to finance forecasted increases in assets.

When forecasting income statements, which of the following is generally a key assumption firms make about their variable operating costs?

e. Variable operating costs increase at the same rate as sales.

By definition, a firm's operating breakeven point represents the level of production and sales at which its _____.

net operating income is equal to zero

Which of the following account balances is most likely to change spontaneously with changes in sales?

Accounts payable

New World Manufacturing has determined that its degree of financial leverage (DFL) is 3.0 when sales equal $750,000, which happens to be its operating breakeven point (i.e., SOpBE = $750,000). At sales equal to $750,000, which of the following conditions must exist for New World Manufacturing? Assume everything else is equal.

Earnings per share (EPS) < 0

The percentage change in earnings before interest and taxes (EBIT) associated with a given percentage change in sales is known as the degree of _____ leverage.

operating

A firm utilizes 75 percent of its plant capacity to produce the current year's sales of $3,000,000. What is the firm's full-capacity sales?

A firm that makes an overly optimistic sales forecast is likely to have a _____.

high depreciation expense

To compute the additional funds (AFN) the firm must raise using external financing sources to support a particular level of forecasted operations, the firm should _____.

subtract the funds it expects to generate internally from the funds that are required to attain the forecasted sales

Which of the following mathematical equations represents the operating breakeven point, QOpBEP, for a firm?

Sales = Total variable costs + Total fixed costs