Solutions to Chapter 18

Solutions to Chapter 18

Financial Planning

1. a. False. Financial planning is a process of deciding which risks to take.

b. False. Financial planning is concerned with possible surprises as well as the most likely outcomes.

c. True. Financial planning considers both the financing and investment decisions. This is one (but not the only) reason that financial planning is necessary.

d. False. A typical horizon for long-term planning is five years.

e. True. Investments are usually aggregated by category.

f. True. Perfect accuracy is unlikely to be obtainable, but the firm needs to produce the most accurate possible consistent forecasts.

g. False. Excessive detail distracts attention from the crucial decisions.

2. a. Most models are accounting-based and do not recognize firm value maximization as the objective of the firm.

b. Often the relationships among variables specified by the model are somewhat arbitrary, and the decisions they imply are not considered explicitly once the model has been constructed. For example, firms have considerably more flexibility in their decisions than would be reflected in a percentage of sales model.

c. Models are expensive to build and maintain.

d. Models are often so complicated that it is difficult to use them or to make changes to them efficiently.

3. The ability to meet or exceed the targets embodied in a financial plan is obviously a reassuring indicator of management talent and motivation. Moreover, the financial plan focuses attention on the specific targets that top management deems most important. There are, however, several dangers.

a. Financial plans are usually accounting-based, and thus are subject to the biases inherent in book profitability measures.

b. Managers may sacrifice the firm’s best long-term interests in order to meet the plan’s short- or medium-run...