Module 11
Forecasting Financial Statements
Learning Objectives – coverage by question
True/False Multiple Choice Exercises Problems Essays
LO1 – Explain the process of
forecasting financial
statements.
LO2 – F
...
Module 11
Forecasting Financial Statements
Learning Objectives – coverage by question
True/False Multiple Choice Exercises Problems Essays
LO1 – Explain the process of
forecasting financial
statements.
LO2 – Forecast revenues and
the income statement.
LO3 – Forecast the balance
sheet. 8-10 10-16 12 2-4 5
LO4 – Forecast the statement
of cash flows.
LO5 – Prepare multiyear
forecasts of financial
statements.
LO6 – Implement a
parsimonious method for
multiyear forecasting of net
operating profit and net
operating assets.
Module 11: Forecasting Financial Statements
True/False
Topic: Eliminating Transitory Activities
LO: 1
1. To forecast future performance, we should first create a set of financial statements that reflects items
we expect to persist.
Answer: True
Rationale: Persistent activities are those that will recur – that is the point of forecasting, to predict
what will recur.
Topic: Conservatism versus Optimism
LO: 1
2. When forecasting future events, it is better to take a more conservative view for items such as
revenue growth and profit margins.
Answer: False
Rationale: The best forecasts are the most realistic ones. Being overly conservative can lead to
missed opportunities.
Topic: Bias Resulting from Accruals
LO: 1
3. Accruals can be used to bias financial statements in order to achieve certain reporting objectives.
Answer: True
Rationale: Managers can use accruals to depress current period income by writing off an excessive
amount of assets and accruing an excessive amount of liabilities (big bath). Managers can also
increase current period income by accruing an insufficient allowance for uncollectible accounts, for
example.
Topic: Adjusting Process
LO: 1
4. The adjusting process is useful for historical analysis, but not for prospective analysis.
Answer: False
Rationale: The adjusting process parses the financial statements into operating/nonoperating and
core/transitory components. It is useful for both historical and prospective analysis.
Topic: Order of Projections
LO: 1
5. The usual financial statement projection process is completed in the following order: balance sheet,
income statement, statement of cash flows.
Answer: False
Rationale: The usual projection process begins with the income statement, followed by the balance
sheet, and finished with the statement of cash flows.
©Cambridge Business Publishers, 2013
11-2 Financial Statement Analysis & Valuation, 3rd EditionTopic: Projecting Revenues
LO: 2
6. An unbiased approach to forecasting future revenues gives equal weight to historical organic revenue
growth and revenue growth from mergers and acquisitions.
Answer: False
Rationale: The most accurate forecast of future revenue is one that considers future organic versus
M&A revenue growth. Historic numbers are informative to the extent that we expect past trends to
continue.
Topic: Projecting Revenues
LO: 2
7. Revenue forecasts derived from unit sales and current prices are usually more accurate than those
derived from dollar sales.
Answer: True
Rationale: Using units and prices allows the forecaster to alter each separately which is a more
dynamic and usually more accurate way to forecast demand and revenue.
Topic: Projections Using Most Current Ratios
LO: 3
8. Projecting balance sheet items is most accurate if we use the most recent ratios.
Answer: False
Rationale: For accurate forecasts, we want to use the most stable and relevant ratios concerning the
company’s financial condition. Sometimes, the most recent ratios are not stable.
Topic: Projecting Property, Plant, and Equipment (PPE)
LO: 3
9. To forecast property, plant, and equipment (PPE) we first determine capital expenditures (CAPEX)
and add that to historical PPE.
Answer: True
Rationale: We do not forecast disposals unless the MD&A specifically mentions them.
Topic: Projection of Cash
LO: 3
10. The forecasting process assumes that the cash on the balance sheet reflects an economically
appropriate balance that we forecast similarly for the next fiscal year.
Answer: True
Rationale: Our forecasting process is to forecast a cash balance and adjust the level of investment
securities or short-term debt to balance the balance sheet.
Topic: Projected Cash-Flow Statement
LO: 4
11. The forecasted statement of cash flow uses either the forecasted income statement or the balance
sheet.
Answer: False
Rationale: The statement of cash flow uses both to explain the change in cash on the balance sheet.
©Cambridge Business Publishers, 2013
Test Bank, Module 11 11-3Topic: Depreciation Expense on the Statement of Cash Flows
LO: 4
12. Depreciation expense, determined as a percentage of actual property, plant, and equipment, is added
back to net income in the operating cash flow section.
Answer: True
Rationale: Depreciation is a noncash expense that does not affect cash.
Topic: Multiyear Forecast
LO: 5
13. The drawback of a multiyear forecast is that the same revenue growth assumption must be used for
each year and this may not be the most accurate assessment of future revenue growth especially for
firms that have not yet reached maturity.
Answer: False
Rationale: Assumptions may vary for each year’s forecast.
Topic: Parsimonious Method of Projection
LO: 6
14. The parsimonious projection method relies on sales growth, net operating profit margin (NOPM), and
asset turnover (AT) to project net operating profit after tax and net operating assets.
Answer: False
Rationale: The parsimonious projection method relies on net operating asset turnover (NOAT) and not
total asset turnover (AT).
Topic: Projecting Property Plant and Equipment With Parsimonious Method
LO: 6
15. The parsimonious projection method is the more efficient method for projecting property, plant and
equipment.
Answer: False
Rationale: The parsimonious projection method does not project individual income statement and
balance sheet items; it is used to project net operating profit (NOPAT) and net operating assets
(NOA).
©Cambridge Business Publishers, 2013
11-4 Financial Statement Analysis & Valuation, 3rd EditionMultiple Choice
Topic: Adjusting Operating Cash Flows
LO: 1
1. Which of the following should an analyst consider moving out of operating cash flows for analysis
purposes?
A) Decreases in accounts payable
B) Decreases in accounts receivable from securitization
C) Increases in inventory
D) Increases in environmental liabilities
E) None of the above
Answer: B
Rationale: Companies often securitize (sell-off) their account receivables which removes the
receivables from the balance sheet, resulting in an increase in operating cash flows. Many analysts
consider this to be a financing, not an operating, activity.
Topic: Adjusting the Income Statement
LO: 1
2. Which of the following is not a typical adjustment made to the income statement for projection
purposes?
A) Adjusting net income for perceived under- or over-accruals
B) Adjusting revenues to only include organic revenue growth
C) Separating operating and non-operating items
D) Removing transitory items such as restructuring charges
E) None of the above
Answer: B
Rationale: Distinguishing between organic and acquired income is important because acquired
growth is expensive. However, the acquired income should be considered for projection purposes as
long as the expenditures to acquire that income are included in the projections.
Topic: Adjusting the Balance Sheet
LO: 1
3. What adjustments might you consider making to the balance sheet before you began the forecasting
process?
A) Capitalization of operating leases
B) Consolidation of equity method investments
C) Elimination of impaired goodwill not recognized yet by the company
D) All of the above
Answer: D
Rationale: All of these adjustments are legitimate, helpful adjustments.
©Cambridge Business Publishers, 2013
Test Bank, Module 11 11-5Topic: Projecting Revenue (Numerical calculations required)
LO: 2
4. Best Tacos Company reports 2011 and 2012 total revenues of $55 million and $66 million
respectively. If we expect prior growth to persist, we would forecast a revenue growth rate of:
A) 15%
B) 35%
C) 20%
D) 25%
E) None of the above
Answer: C
Rationale: ($66 / $55) – 1 = 0.2 = 20%
Topic: Projecting Revenue (Numerical calculations required)
LO: 2
5. Following are financial statement numbers and ratios for Snap-On Incorporated for the year ended
January 1, 2011 (in millions). If we expected revenue growth of 2% in the next year, what would
projected revenue be for the year ended December 30, 2011?
NOPAT 322.6
NOA 2,345.8
Net operating profit margin (NOPM) 11.3%
Net operating asset turnover (NOAT) 1.31
A) $3,176.7 million
B) $3,739.0 million
C) $2,854.2 million
D) $2,911.3 million
E) None of the above
Answer: D
Rationale: $2,854.2 million × 1.02 = $2,911.3 million
Topic: Projecting Revenue (Numerical calculations required)
LO: 2
6. Following are financial statement numbers and ratios for Lockheed Martin Corp. for the year ended
December 31, 2011. If we expected revenue growth of 2.67% in the next year, what would projected
revenue be for 2012?
Total revenue (in millions)
$46,49
9
Net operating profit margin (NOPM) 8.2%
Net operating asset turnover (NOAT) 6.4
A) $47,740.5 million
B) $50,311.9 million
C) $45,289.8 million
D) $49,474.9 million
E) None of the above
Answer: A
Rationale: $46,499 million × 1.0267 = $47,740.5 million
©Cambridge Business Publishers, 2013
11-6 Financial Statement Analysis & Valuation, 3rd EditionTopic: Projected COGS (Numerical calculations required)
LO: 2
7. The Egg Basket Inc. reports in its 2012 10-K, sales of $1,130 million and cost of goods sold of $452
million. For next year, you project that sales will grow by 6% and that cost of goods sold percentage
will be 1 percentage point higher. Projected cost of goods sold for 2012 will be:
A) $480 million
B) $491 million
C) $484 million
D) $496 million
E) There is not enough information to determine the amount.
Answer: B
Rationale: $1,130 million ×1.06 × (($452 / $1,130) +1%) = $491 million
Topic: Projected Interest Expense (Numerical calculations required)
LO: 2
8. YoYo Company reports in its 2012 10-K, sales of $96 million, long-term debt of $10 million, and
interest expense of $1,000,000. If sales are projected to increase by 4.1% next year, projected
interest expense for 2012 will be:
A) $ 900,000
B) $1,041,000
C) $ 940,000
D) $1,000,000
E) None of the ab
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