Finance: Generally Accepted Accounting Principles and Growth Rate
Chapter 12
Corporate Valuation and Financial Planning
ANSWERS TO END-OF-CHAPTER QUESTIONS
12-1 a. The operating plan provides detailed implementation guidance designed to accomplish corporate objectives. It details who is responsible for what particular function, and when specific tasks are to be accomplished. The financial plan details the financial aspects of the corporation’s operating plan.
b. Spontaneous liabilities are the first source of expansion capital as these accounts increase automatically through normal business operations. Examples of spontaneous liabilities include accounts payable, accrued wages, and accrued taxes. No interest is normally paid on these spontaneous liabilities; however, their amounts are limited due to credit terms, contracts with workers, and tax laws. Therefore, spontaneous liabilities are used to the extent possible, but there is little flexibility in their usage. Note that notes payable, although a current liability account, is not a spontaneous liability since an increase in notes payable requires a specific action between the firm and a creditor. A firm’s profit margin is calculated as net income divided by sales. The higher a firm’s profit margin, the larger the firm’s net income available to support increases in its assets. Consequently, the firm’s need for external financing will be lower. A firm’s payout ratio is calculated as dividends per share divided by earnings per share. The less of its income a company distributes as dividends, the larger its addition to retained earnings. Therefore, the firm’s need for external financing will be lower.
c. Additional funds needed (AFN) are those funds required from external sources to increase the firm’s assets to support a sales increase. A sales increase will normally require an increase in assets. However, some of this increase is usually offset by a spontaneous increase in liabilities as well as by earnings retained in the firm. Those funds that are
Corporate Valuation and Financial Planning
ANSWERS TO END-OF-CHAPTER QUESTIONS
12-1 a. The operating plan provides detailed implementation guidance designed to accomplish corporate objectives. It details who is responsible for what particular function, and when specific tasks are to be accomplished. The financial plan details the financial aspects of the corporation’s operating plan.
b. Spontaneous liabilities are the first source of expansion capital as these accounts increase automatically through normal business operations. Examples of spontaneous liabilities include accounts payable, accrued wages, and accrued taxes. No interest is normally paid on these spontaneous liabilities; however, their amounts are limited due to credit terms, contracts with workers, and tax laws. Therefore, spontaneous liabilities are used to the extent possible, but there is little flexibility in their usage. Note that notes payable, although a current liability account, is not a spontaneous liability since an increase in notes payable requires a specific action between the firm and a creditor. A firm’s profit margin is calculated as net income divided by sales. The higher a firm’s profit margin, the larger the firm’s net income available to support increases in its assets. Consequently, the firm’s need for external financing will be lower. A firm’s payout ratio is calculated as dividends per share divided by earnings per share. The less of its income a company distributes as dividends, the larger its addition to retained earnings. Therefore, the firm’s need for external financing will be lower.
c. Additional funds needed (AFN) are those funds required from external sources to increase the firm’s assets to support a sales increase. A sales increase will normally require an increase in assets. However, some of this increase is usually offset by a spontaneous increase in liabilities as well as by earnings retained in the firm. Those funds that are