Entrepreneurial Finance 5th Edition

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 CHAPTER 9

PROJECTING FINANCIAL STATEMENTS

True-False Questions

F. 1. Long-term financial planning begins with a forecast of annual working

capital needs.

T. 2. In a typical venture’s life cycle, the rapid-growth stage involves creating and
building value, obtaining additional financing, and examining exit
opportunities.

T. 3. Forecasting for firms with operating histories is generally much easier than
forecasting for early-stage ventures.

T. 4. Sales forecasts usually are based on either a single specific scenario or

weighted averages of several possible realizations.

T. 5. The weighted average of a set of possible outcomes or scenarios is known

as expected values.

F. 6. A customer-driven or “bottom-up” approach to forecasting sales is used

primarily to forecast industry sales growth rates.

F. 7. Sales forecasting accuracy is usually highest during a venture’s startup

stage in its life cycle.

F. 5. “Public or seasoned financing” typically occurs during the survival stage of

a venture’s life cycle.

F. 8. The volatility of a firm’s cash balance will steadily decreases as the firm
progresses from the survival stage to the rapid-growth stage.

F. 9. “First-round financing” usually occurs during a venture’s rapid-growth life

cycle stage.

T. 10. Sales forecasting accuracy is usually lowest during a venture’s

development stage in its life cycle.

F. 11. “Internally generated funds” is the cash produced from operating a firm
over a specified time period.

T. 12. The rate at which a firm can grow sales based on the retention of business
profits is known as sustainable sales growth rate.

38
 Chapter 9: Projecting Financial Statements 39

T. 13. A firm’s maximum sustainable sales growth rate occurs at a retention ratio
of 100%.

T. 14. When using the beginning of period equity base, the sustainable sales
growth rate is equal to ROE times the retention ratio.

F. 15. The sustainable sales growth rate is equal to ROA times the retention ratio.

T. 16. “Financial capital needed” (FCN) is the amount of funds needed to

acquire assets necessary to support a firm’s sales growth.

T. 17. The cost of obtaining additional funds, such as additional interest expenses
from borrowing funds, may be explicit and impact AFN.

F. 18. The added costs associated with obtaining equity capital are based on
investor expected rates of return and are explicit costs which affect AFN.

T. 19. “Additional funds needed” (AFN) is the gap remaining between the
financial capital needed and that funded by spontaneously generated funds and
retained earnings.

T. 20. Increases in accounts receivable and accounts payable that accompany

sales increases are called “spontaneously generated funds”.

F. 21. “Spontaneously generated funds” are increases in accounts receivable and

accounts payable that accompany sales increases.

F. 22. Increases in accounts payable and notes payable are examples of

spontaneously generated funds.

F. 23. A firm with a positive growth rate in sales will require some additional
funds, assuming the existing ratios will not be changed.

T. 24. An increase in accounts receivable will require additional financing unless

the increase is offset by an equal decrease in another asset account.

F. 25. The percent of sales forecasting method must project all cost and balance
sheet items at the same growth rate as sales.

T. 26. The “constant-ratio forecasting method” is a variant of the “percent-of-

sales forecasting method.”
40 Chapter 9: Projecting Financial Statements

F. 27. The constant ratio forecasting method makes projections based on the
assumption that certain costs and some balance sheet items are best expressed
as a percentage of sales.

Multiple-Choice Questions

e. 1. Which of the following is not a step in forecasting sales for a seasoned

firm?
a. forecast future growth rates based on possible scenarios and the
probabilities of those scenarios.
b. attempt to corroborate the projected sales growth rates analyzing
both industry growth rates and the firm’s own past market share.
c. refine the sales forecast by using the sales force as a direct contact
with both existing and potential customers.
d. take into consideration the likely impact of major operating changes
within the firm on the sales forecast.
e. consider the effects of changes in the firm’s debt/equity blend on
the sales forecasts.

c. 2. Which of the following statements is incorrect?

a. forecasting sales is the first step in creating projected financial
statements
b. financial forecasting tends to be more accurate for mature ventures
than for early-stage ventures
c. forecasting is relatively unimportant for early-stage ventures with
little historical financial data
d. a and b
e. a and c

a. 3. During which round of financing is a venture typically most accurate in

forecasting sales?
a. seasoned financing
b. mezzanine financing
c. first round financing
d. startup financing
e. seed financing

d. 4. During which life cycle stage is a venture typically most accurate in

forecasting sales?
a. rapid growth stage
b. startup stage
c. development stage
d. early-maturity stage
e. survival stage
 Chapter 9: Projecting Financial Statements 41

e. 5. Public or seasoned financing is generally associated with which one of the

following life cycle stages:
a. development stage
b. startup stage
c. survival stage
d. rapid-growth stage
e. early-maturity stage

a. 6. A “new” venture usually begins its sales forecast by first:

a. forecasting industry sales and expressing the venture’s sales as a
percent of industry sales
b. using a “bottom-up” market-driven approach
c. extrapolating past sales
d. working with existing and potential customers

b. 7. An “expected value” is:

a. a simple average of a set of scenarios or possible outcomes
b. a weighted average of a set of scenarios or possible outcomes
c. the highest scenario value or outcome
d. the lowest scenario value or outcome

b. 8. Lola is in the process of forecasting the sales growth rate for an early-stage
venture specializing in the production of durable running shoes. Lola predicts a
.2 probability of an 80% growth in sales, a .3 probability of a 60% growth in
sales, a .4 probability of a 40% growth in sales, and a .1 probability of a 10%
decrease in sales. What is the expected sales growth rate of the venture?
a. 47%
b. 49%
c. 51%
d. 53%

d. 9. Which one of the following life cycle stages would generally be associated
with the second lowest sales forecasting accuracy?
a. early-maturity
b. rapid-growth
c. survival
d. start-up
e. development

c. 10. Internally generated funds which are available for distribution to owners of
for reinvestment back into the business to support future growth can be
characterized by which of the following?
a. operating income
b. operating cash flow
c. net income
42 Chapter 9: Projecting Financial Statements

d. net cash flow

e. pre-tax income

b. 11. Which of the following is not part of the financial forecasting process used
to project financial statements?
a. forecast sales
b. forecast tax rates
c. project the income statement
d. project the balance sheet
e project the statement of cash flows

b. 12. A firm projects net income to be $500,000, intends to pay out $125,000 in
dividends, and had $2 million of equity at the beginning of the year. The
firm’s sustainable growth rate is:
a. 5%
b. 18.75%
c. 6.25%
d. 4.69%
e. none of the above

b. 13. A firm has net income of $320,000 on sales of $3,200,000. Its assets total
$2,000,000; the equity at the beginning of the year was $1,600,000 and
dividends paid were $80,000. What is the sustainable growth rate?
a. 5%
b. 15%
c. 6.25%
d. 4.69%
e. none of the above

b. 14. A sales growth rate based on the retention of profits is referred to as the:
a. real sales growth rate
b. sustainable sales growth rate
c. spontaneous sales growth rate
d. nominal sales growth rate
e. weighted average sales growth rate

d. 15. Which one of the following ratios is not part of the “standard” return on
equity (ROE) model?
a. net profit margin
b. asset turnover
c. equity multiplier
d. retention rate

c. 16. If beginning of period common equity is $200,000 and end of period

common equity is $300,000, the sustainable growth rate is:
 Chapter 9: Projecting Financial Statements 43

a. 33%
b. 40%
c. 50%
d. 67%
e. 75%

d. 17. Use the following information to estimate a venture’s sustainable growth

rate: Net income = $200,000; Total assets = $1,000,000; equity multiple based
on beginning common equity = 2.0 times; and Retention rate = 25%.
a. 50%
b. 25%
c. 20%
d. 10%
e. 5%

b. 18. If a venture has a return on assets (ROA) = 10%, an equity multiplier

based on beginning equity = 3.5 times, and a retention rate = 50%, the
sustainable growth rate would be:
a. 10%
b. 17.5%
c. 35%
d. 40%
e. 20.5%

b. 19. If a venture has a return on assets (ROA) = 10%, an equity multiplier

based on beginning equity = 4.0 times, and a dividend payout ratio of 60%, the
sustainable growth rate would be:
a. 10%
b. 16%
c. 20%
d. 24%
e. 40%

e. 20. If a venture has a return on assets (ROA) = 12%, an equity multiplier

based on beginning equity = 3.0 times, and a sustainable growth rate of 18%,
the retention rate would be:
a. 10%
b. 20%
c. 30%
d. 40%
e. 50%

d. 21. A venture’s common equity was $50,000 at the end of last year. If the
venture’s common equity at the end of this year was $60,000, what was its
sustainable sales growth rate?
44 Chapter 9: Projecting Financial Statements

a. 5%
b. 10%
c. 15%
d. 20%
e. 25%

e. 22. A venture’s common equity account increased by $100,000 the past year
and ended the year at $500,000. What was its sustainable sales growth rate?
a. 5%
b. 10%
c. 15%
d. 20%
e. 25%

a. 23. Determine a venture’s sustainable growth rate based on the following

information: sales = $1,000,000; net income = $100,000; common equity at
the beginning of the year = $500,000; and the retention rate = 50%.
a. 10%
b. 15%
c. 20%
d. 25%
e. 30%

e. 24. Determine a venture’s sustainable growth rate based on the following

information: sales = $1,000,000; net income = $150,000; common equity at
the end of last year = $520,000; and the dividend payout percentage = 20%.
a. 10%
b. 16%
c. 20%
d. 24%
e. 30%

a. 25. Determine a firm’s “financial policy” multiplier based on the following

information: sustainable growth rate = 20%; net profit margin = 10%; and
asset turnover = 2 times.
a. 1.00
b. 1.25
c. 1.50
d. 1.75
e. 2.00

e. 26. Determine a firm’s “return on assets” percentage based on the following

information: sustainable growth rate = 20%; total assets $500,000; beginning
of year common equity $200,000; and dividend payout percentage = 60%.
a. 10.0%
 Chapter 9: Projecting Financial Statements 45

b. 12.5%
c. 15.0%
d. 17.5%
e. 20.0%

d 27. The financial funds needed to acquire assets necessary to support a firm’s
sales growth is called:
a. spontaneously generated funds
b. additional funds needed
c. addition in retained earnings
d. financial capital needed

a. 28. The increase in accounts payables and accruals that occur with a sales
increase is called:
a. spontaneously generated funds
b. additional funds needed
c. addition in retained earnings
d. financial capital needed

b. 29. The financial funds still needed to finance asset growth after using
spontaneously generated funds and any increase in retained earnings is called:
a. spontaneously generated funds
b. additional funds needed
c. addition in retained earnings
d. financial capital needed

d. 30. Which one of the following would increase a firm’s need for additional
funds?
a. an increasing profit margin
b. a decreasing expected sales growth rate
c. an increase in accruals
d. an increasing dividend payout rate
e. a decrease in assets

c. 31. Your firm recorded sales for the most recent year of $10 million generated
from an asset base of $7 million, producing a $500,000 net income. Sales are
projected to grow at 20%, causing spontaneous liabilities to increase by
$200,000. In the most recent year, $200,000 was paid out as dividends, and
the current payout ratio will continue in the upcoming years. What is your
firm’s AFN?
a. $200,000
b. $600,000
c. $840,000
d. $960,000
e. $1,400,000
46 Chapter 9: Projecting Financial Statements

a. 32. Which of the following is a forecasting method used to project financial

statements?
a. percent-of-sales method
b. percent-of-expenses method
c. GNP-ratio method
d. a and b
e. a, b, and c

b. 33. When projecting financial statements, one would first , and then
proceed to :
a. project of the balance sheet, forecast sales.
b. forecast sales, project the income statement
c. forecast sales, project the balance sheet
d. forecast sales, project the statement of cash flows