Term
| The balancing problem in forecasting refers to |
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Definition
| the cost of new debt and its impact on forecasting retained earnings |
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Term
Which of the following items on the income statement and balance sheet is most likely to vary spontaneously with sales?
notes payable
B. common stock
C. accrued expenses
D. capital in excess of par |
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Definition
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Term
| Additional funds needed represents: |
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Definition
| the amount needed to achieve the necessary asset growth |
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Term
| Sales will grow from $100,000 this year to $150,000 next year. Preferred dividends were $10,000 this year. What is the new projected amount of preferred dividends? |
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Definition
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Term
Which of the following items on the income statement and balance sheet is least likely vary spontaneously with sales?
plant and equipment
B. accounts payable
C. accrued expenses
D. cost of goods sold |
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Definition
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Term
Each of the following items on the income statement and balance sheet tend to vary spontaneously with sales except?
. cost of goods sold
B. accumulated depreciation
C. selling expenses
D. taxes |
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Definition
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Term
| financial plan consisting of projected future financial statements are called: |
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Definition
pro forma financial statements
Hint: “In the form of” is the key here! |
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Term
Which of the following does not represent a financial plan?
Cash budget
B. Capital budget
C. Pro forma income statement
D. A balance sheet |
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Definition
A balance sheet
Hint: A financial plan looks ahead. |
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Term
Which one of the following is not a method of forecasting future business activity?
A. Analysis of last year’s financial statements
B. Using last year’s financial statements to forecast next year’s
C. Probability analysis of future sales levels.
D. Correlation of activity with other variables. |
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Definition
Response Value Correct Answer Feedback
A. Analysis of last year’s financial statements |
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Term
Which of the following pro forma statements is likely to be calculated first by the financial manager who is creating next year’s financial plan?
. Statement of cash flow
B. Balance sheet
C. Income statement
D. Statement of changes in shareholders’ equity |
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Definition
Income statement
Hint: Where is the primary “independent” variable for the plan found? |
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Term
Which of the following income statement accounts is not likely to vary with sales?
Cost of goods sold
B. Depreciation expense
C. Selling expenses
D. Net income |
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Definition
Depreciation expense
Hint: Which of the following is a function of something other than sales? |
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Term
Which of the following balance sheet accounts is not likely to vary directly with changes in sales?
A. Accounts receivables
B. Inventory
C. Accounts payable
D. Long-term debt |
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Definition
Long-term debt
Hint: Which of the following is affected least by sales? |
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Term
In the pro forma balance sheet, which of the following is normally the “plug” number inserted to “balance” the balance sheet?
Long-term debt
B. Increases in retained earnings
C. Additional funds needed
D. Total assets |
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Definition
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Term
| Amex Corporation forecasts a 15% increase in sales, and similar effects for its accounts receivable ($3 million), inventory ($4 million), and accounts payable ($3.5 million). All other financial statement accounts will remain the same, and Amex will pay out all earnings to shareholders as dividends. What is Amex’s expected additional funds needed? |
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Definition
$525,000
Hint: Estimate the changes in net working capital? |
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Term
| Jones Corp. expects sales to increase 10% from this year’s level of $5 million. With a net profit margin of 8% and a dividend payout ratio of 30%, what financing for next year might be provided from internal equity sources? |
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Definition
$440,000
B. $132,000
$308,000
Hint: What added funds will be provided from added retained earnings? |
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Term
| A company with rapidly growing sales is likely to experience |
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Definition
| A great need for additional funding from outside the firm |
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Term
When we compare the risk of two investments that have the same expected return, the coefficient of variation:
provides no additional information than the standard deviation
B. adjusts for the correlation between the two instruments
C. gives conflicting results compared to the standard deviation
D. always gives us a value between 0 and 1 |
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Definition
| provides no additional information than the standard deviation |
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Term
What is the coefficient of variation of the following income statement sales projection given the following information?
Possible Sales Level (in 000's) Probability
1000 10%
2000 15%
2500 50%
2800 20%
3000 5% |
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Definition
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Term
What is the standard deviation of the following income statement sales projection given the following information?
Possible Sales Level (in 000's) Probability
0 10%
100 15%
400 40%
450 30%
600 5% |
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Definition
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Term
| The expected return on an investment is: |
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Definition
| the mean of the distribution of possible returns |
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Term
What is the expected return given the following information?
Possible Returns Probability
8% 20%
10% 10%
12% 40%
15% 20%
16% 10% |
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Definition
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Term
| In terms of risk, labor union disputes, entry of a new competitor, and embezzlement by management are all examples of factors affecting: |
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Definition
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Term
| If the distribution of possible future sales values is normal, then the probability that actual sales will be the expected value plus or minus one standard deviation is approximately? |
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Definition
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Term
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Definition
| numerical indicator of how widely dispersed possible values are distributed around the mean |
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Term
| You are trying to diversify your portfolio and reduce risk. Which of the following correlations between the returns of your portfolio and those of a proposed addition would give the most diversification benefit (other things equal)? |
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Definition
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Term
A good measure of an investor's risk exposure if she/he only holds a single asset in her portfolio is:
. the standard deviation of possible returns on the asset
B. the expected value of the asset's returns
C. the correlation coefficient with the market portfolio
D. the normal probability distribution function |
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Definition
| the standard deviation of possible returns on the asset |
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Term
Most investors are risk _______, desiring a higher rate of return for added risk assumed.
preferent
B. adjusted
C. averse
D. seeking |
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Definition
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Term
Which one risk measure, utilizing the concept of frequency distributions, seeks to measure the variability of future returns around the expected value?
Standard deviation
B. Mean
C. Correlation
D. Probability |
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Definition
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Term
| The standard deviation is the: |
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Definition
| square root of the sum of the squared deviations from the mean times the probability of occurrence. |
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Term
| Assuming a normal distribution, if the average return on an investment is 15%, which of the following standard deviations represents the highest risk? |
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Definition
15%
General Feedback: Hint: The standard deviation is quoted in the same terms as the mean. |
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Term
| While the standard deviation is an absolute measure of variability, the coefficient of variation, measured by the ________________, is a(n) _________ measure of riskiness. |
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Definition
| standard deviation divided by the mean; relative |
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Term
| While the standard deviation is an absolute measure of variability, the coefficient of variation, measured by the ________________, is a(n) _________ measure of riskiness. |
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Definition
| standard deviation divided by the mean; relative |
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Term
| While the standard deviation is an absolute measure of variability, the coefficient of variation, measured by the ________________, is a(n) _________ measure of riskiness. |
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Definition
| standard deviation divided by the mean; relative |
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Term
Business risk is associated with variations in operating income caused by sales fluctuations magnified by _______________ that produce greater percent changes in EBIT than the percent change in sales.
total gross profit
B. fixed operating costs
C. variable operating costs
D. total interest expense |
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Definition
fixed operating costs
General Feedback: Hint: What income statement accounts are between sales and EBIT? |
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Term
| When adding financial risk to business risk: |
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Definition
| the total risk is increased by the compounding effects of the combined risks. |
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Term
| A well diversified stock portfolio will: |
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Definition
remove the diversifiable risk, leaving only the nondiversifiable risk of the stock portfolio.
Hint: What is the effect of diversification on total risk or variability of the return on the stock portfolio? |
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Term
| The Capital Asset Pricing Model suggests that an individual stock’s required rate of return is the sum of: |
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Definition
the risk-free rate plus the market risk premium times the beta of the stock.
Hint: This is the classic risk/return tradeoff |
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Term
| The stock beta is a measure of: |
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Definition
the return of the individual stock relative to the return of the market.
Hint: It is a component of the CAPM. |
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Term
| Why is forecasting important? |
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Definition
Mistakes are costly:
If you produce too much of a product, or a product that no one wants to buy, you still must pay for materials, labor, and storage.
If you produce too little of a product, you will lose sales and possibly market share. |
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Term
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Definition
Experience
Probability
Correlation
Financial managers concentrate on three general approaches to financial forecasting |
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Term
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Definition
Managers who have been in the business for a long time have developed a sense for the patterns in sales, expenses, consumer demand factors, etc.
Example: Editors who work for book publishers regularly read submitted manuscripts and make judgments about whether their company should buy the rights to publish the books. |
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Term
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Definition
Past history often tells us a lot about what will happen in the future.
Managers can use this information to estimate the future.
Example: In the past, a 7-11 manager has found that she will lose 1% of candy inventory to shoplifters. She can use this information to estimate future losses and also to design better controls. |
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Term
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Definition
Correlation is a measure of the relative movement of two variables relative to each other.
Example: If interest rates go up, a real estate agent knows that home sales will tend to fall (because the higher cost of financing makes it harder for buyers to qualify for mortgages).
Example: Sales of umbrellas are higher in rainy seasons. |
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Term
| Pro Forma Financial Statements |
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Definition
| Pro forma financial statements are forecasts of the firm’s future financial statements based on a certain set of assumptions about sales trends and the relationships between sales and various financial variables, and between other financial statement variables relative to each other. |
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Term
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Definition
If outside financing is required, the new debt or equity may affect your original projections of the amount of the addition to retained earnings (due to increased interest or dividends on the income statement). This is called the “balancing problem”
In this case, the pro forma should be recast with the new information to make final projections of AFN. |
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Term
| Producing Pro Formas - Summary |
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Definition
Determine sales growth.
Calculate projected net income.
Project assets needed to support the new sales level.
Project increases in spontaneous asset and liability accounts.
Project addition to retained earnings.
Determine the difference between projected assets and projected liabilities & equity. |
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Term
Forecast increase in
retained earnings. |
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Definition
New retained earnings
=Old retained earnings
+ additions to ret. earnings
=1.5 + [NI x (1-div. payout)]
=1.5 + [.712 x (1-.7)] = 1.7 |
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Term
Producing Pro Formas
Hold other accounts constant
to see how much additional
funds will be needed. |
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Definition
Long Term Debt
Common Stock |
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Term
Additional funds needed
(AFN) =
how do you get those funds? |
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Definition
Additional funds needed
(AFN) = projected assets
minus projected claims
Using: Notes Payable, and/or LT Debt, and/or Common Stock |
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Term
Expected return
standard deviation |
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Definition
Expected return is the mean of the probability distribution of possible returns.
Future returns are not known with certainty. The standard deviation is a measure of this uncertainty |
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Term
|
Definition
Expected return is the mean of the probability distribution of possible returns.
Future returns are not known with certainty
To calculate expected return, compute the weighted average of possible returns
Average |
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Term
| When comparing risk between two investment |
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Definition
options we can only rely on standard deviation if, and only if, they have the same mean.
If they have different means then we use a measure called Coefficient of Variation (CV).
CV Calculation is easy:
CV = std dev/mean
CV = (standard deviation divided by the mean) |
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Term
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Definition
Risk due to factors within the firm
Example: Stock price will most likely fall if major government contract is lost unexpectedly.
Diversification can effectively eliminate firm specific (un-systematic) risk
can be eliminated with diversivaction |
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Term
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Definition
Risk due to overall market conditions
Example: Stock price is likely to rise if overall stock market doing well
Diversification does not reduce market related (systemic) risk |
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