Concepts Review and Critical Thinking Questions

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1. Sales Forecast Why do you think most long-term financial planning begins with sales forecasts? Put differently, why are future sales the key input?

2. Long Range Financial Planning Would long-range financial planning be more important for a capital intensive company, such as a heavy equipment manufacturer, or an import-export business? Why?

3. External Financing Needed Testaburger, Inc., uses no external financing and maintains a positive retention ratio. When sales grow by 15 percent, the firm has a negative projected EFN. What does this tell you about the firm's internal growth rate? How about the sustainable growth rate? At this same level of sales growth, what will happen to the projected EFN if the retention ratio is increased? What if the retention ratio is decreased? What happens to the projected EFN if the firm pays out all of its earnings in the form of dividends?

4. EFN and Growth Rates Broslofski Co. maintains a positive retention ratio and keeps its debt-equity ratio constant every year. When sales grow by 20 percent, the firm has a negative projected EFN. What does this tell you about the firm's sustainable growth rate? Do you know, with certainty, if the internal growth rate is greater than or less than 20 percent? Why? What happens to the projected EFN if the retention ratio is increased? What if the retention ratio is decreased? What if the retention ratio is zero?

Use the following information to answer the next six questions: A small business called The Grandmother Calendar Company began selling personalized photo calendar kits in 1992. The kits were a hit, and sales soon sharply exceeded forecasts. The rush of orders created a huge backlog, so the company leased more space and expanded capacity, but it still could not keep up with demand. Equipment failed from overuse and quality suffered. Working capital was drained to expand production, and, at the same time, payments from customers were often delayed until the product was shipped. Unable to deliver on orders, the company became so strapped for cash that employee paychecks began to bounce. Finally, out of cash, the company ceased operations entirely in January 1995.

5. Product Sales Do you think the company would have suffered the same fate if its product had been less popular? Why or why not?

6. Cash Flow The Grandmother Calendar Company clearly had a cash flow problem. In the context of the cash flow analysis we developed in Chapter 2, what was the impact of customers' not paying until orders were shipped?

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