Financial Forecasting

Question 1

The main inputs of forecasting include:

Answer 1

time series, cross-sectional and longitudinal data, or using judgmental methods.

Question 2

Forecasting is

Answer 2

the process of making statements about events whose actual outcomes (typically) have not yet been observed.

Question 3

Time series is

Answer 3

a sequence of data points, measured typically at successive time instants spaced at uniform time intervals. Cross-sectional data refers to data collected by observing many subjects at the same point of time, or without regard to differences in time.

Question 4

A longitudinal data involves

Answer 4

repeated observations of the same variables over long periods of time—often many decades.

Question 5

Judgmental forecasting methods incorporate

Answer 5

intuitive judgements, opinions and subjective probability estimates.

Question 6

Probability sample:

Answer 6

a technique of studying a population subset in which the likelihood of getting any particular subset may be calculated.

Question 7

Dow Jones index:

Answer 7

an index that shows how 30 large publicly-owned companies based in the United States have traded during a standard trading session in the stock market.

Question 8

Nonprobability sample:

Answer 8

a subset of the population in which the probability of getting any particular sample may be calculated, and therefore cannot be used to represent the whole population.

Question 9

In corporate finance, investment banking, and the accounting profession, financial modeling is largely synonymous with

Answer 9

cash flow forecasting.

Question 10

Time series is

Answer 10

a sequence of data points, measured typically at successive time instants and spaced at uniform time intervals.

Question 11

Cross-sectional data refers to

Answer 11

data collected by observing many subjects (such as individuals, firms or countries/regions) at the same point in time, or without regard to differences in time. Analysis of cross-sectional data usually consists of comparing the differences among the subjects.

Question 12

Judgmental forecasting methods incorporate

Answer 12

intuitive judgements, opinions and subjective probability estimates, such as Composite forecasts, Delphi method, Forecast by analogy, Scenario building, Statistical surveys, and Technology forecasting.

Question 13

Spontaneous assets are

Answer 13

the assets of a company that are accumulated automatically as a result of the firm’s day-to-day business. Spontaneous liabilities are the obligations of a company that are accumulated automatically as a result of the firm’s day-to-day business.

Question 14

The internal growth rate is

Answer 14

a formula for calculating the maximum growth rate a firm can achieve without resorting to external financing.

Question 15

Sustainable growth is defined as

Answer 15

the annual percentage of increase in sales that is consistent with a defined financial policy.

Question 16

Another measure of growth, the optimal growth rate, assesses

Answer 16

sustainable growth from a total shareholder return creation and profitability perspective, independent of a given financial strategy.

Question 17

Retention:

Answer 17

the act of retaining; something retained.

Question 18

Retention ratio:

Answer 18

retained earnings divided by net income.

Question 19

Sustainable growth rate:

Answer 19

the optimal growth from a financial perspective assuming a given strategy with clear defined financial frame conditions/ limitations.

Question 20

ROE may be calculated either

Answer 20

directly as net income/equity or via the DuPont formula SGR = ROE (1 − b) = NI/S × S/A × A/E × (1 − b)

Question 21

The internal growth rate is

Answer 21

a formula for calculating maximum growth rate that a firm can achieve without resorting to external financing. It’s essentially the growth that a firm can supply by reinvesting its earnings. This can be described as (retained earnings) / (total assets), or conceptually as the total amount of internal capital available compared to the current size of the organization.

Question 22

We find the internal growth rate by

Answer 22

dividing net income by the amount of total assets (or finding return on assets) and multiplying by the rate of earnings retention.

Question 23

Another measure of growth, the optimal growth rate, assesses

Answer 23

sustainable growth from a total shareholder return creation and profitability perspective, independent of a given financial strategy.

Question 24

AFN is

Answer 24

“additional funds needed,” and refers to the additional resources that will be needed for a company to expand its operations. AFN is also known as “Discretionary Financing Needed” or (DFN) and External Financing Need (EFN).

Question 25

AFN is a way of

Answer 25

calculating how much new funding will be required, so that the firm can realistically look at whether or not they will be able to generate the additional funding and therefore be able to achieve the higher sales level.

Question 26

The simplified formula is: AFN =

Answer 26

Projected increase in assets – spontaneous increase in liabilities – any increase in retained earnings. If this value is negative, this means the action or project which is being undertaken will generate extra income for the company, which can be invested elsewhere.

Question 27

The mathematical formulas used to determine AFN are based on

Answer 27

showing how liabilities will grow relative to new assets and sales when a project is undertaken and can be used as tools to determine whether a project or operational expansion is worthwhile.

Question 28

Capacity adjustment takes into account

Answer 28

maximum production levels and the alteration of this level depending on how the firm wants to grow.

Question 29

Capacity planning is the process of

Answer 29

determining the production capacity needed by an organization to meet changing demands for its products.

Question 30

Capacity utilization is a concept in economics and managerial accounting which refers to

Answer 30

the extent to which an enterprise or a nation actually uses its installed productive capacity.

Question 31

Capacity:

Answer 31

the maximum that can be produced on a machine or in a facility or group.

Question 32

Capitalism:

Answer 32

a socio-economic system based on private property rights, including the private ownership of resources or capital, with economic decisions made largely through the operation of a market unregulated by the state.

Question 33

Discretionary Financing Need is the difference between

Answer 33

total assets and total liabilities and owner’s equity.

Question 34

Which statement regarding financial forecasting is correct?

Answer 34

The most difficult aspect of preparing a financial forecast is predicting revenue.

Question 35

Company X has decided to merge with another business. It is planning on preparing a pro forma income statement. Which condition should be included in the pro forma statement?

Answer 35

How much the company’s revenues will increase due to the merger, How much the merged company’s income tax expense will increase, If the merged company will have increased Research & Development (R&D) expenses

Question 36

In the percent-of-sales forecasting method, which balance sheet items are not assumed to increase proportionately with sales?

Answer 36

Long-term debt is a non-spontaneous account and will not increase proportionately with sales.

Question 37

Suppose a firm has a net profit margin of 15%, sales of $155 million, assets of $312 million, and owner’s equity of $223 million. If the dividend payout ratio is 10%, what is the firm’s sustainable growth rate?

Answer 37

SGR = ROE (1-b) = [0.15 x (155/312) x (312/223)] x (1-0.1) = 9.38%

Question 38

A company had $1 million in sales last year, $1.5 million in sales this year, and projected net income of $250,000. Last year, it had $5 million of its assets tied to sales, $3 million in sales-affected liabilities, and a retention ratio of 0.3. What is its AFN?

Answer 38

The correct formula to calculate AFN is: Projected increase in assets – spontaneous increase in liabilities – any increase in retained earnings. = $925,000