CH-4 Financial Forecasting – Foundations of Financial Management : Book Guide

CHAPTER 4 Discussion Questions 4-1. The pro-forma financial statements and cash budget enable the firm to determine its future level of asset needs and the associated financing that will be required. Furthermore, one can track actual events against the projections. Bankers and other lenders also use these financial statements as a guide in credit decisions. 4-2. The collections and purchase schedules measure the speed at which receivables are collected and purchases are paid. To the extent collections do not cover purchasing costs and other financial requirements, the firm must look to borrowing to cover the deficit. 4-3. LIFO inventory valuation assumes the latest purchased inventory becomes part of the cost of goods sold, while the FIFO method assigns inventory items that were purchased first to the cost of goods sold. With inflation the LIFO method will result in a higher cost of goods sold figure and one that more accurately matches the sales dollars recorded at current dollars. 4-4. The more rapid the turnover of inventory, the greater the need for purchase and replacement. Rapidly turning inventory makes for somewhat greater ease in foreseeing future requirements and reduces the cost of carrying inventory. 4-5. Considering sustainable growth rates, one can envision situations where a firm with moderate profitability (say ROE = 8%) grows much quicker (say sales growth of 30% per year). With no access to outside equity funding the growth in the firm’s debt ratios required to support the sales growth might alarm lenders so that they are unwilling to advance more funds and may demand repayment of the existing loans. Growing faster than the internally sustainable growth rate is not a good strategy for firms whose return on investment prospects is less than other comparable investments. Incremental profits from sales expansion seldom meet new financing needs. 4-6. Level production in a cyclical industry has the advantage of allowing for the maintenance of a stable work force and reducing inefficiencies caused by shutting down production during slow periods and accelerating work during crash production periods. A major drawback is that a large stock of inventory may be accumulated during the slow sales period. This inventory may be expensive to finance, with an associated danger of obsolescence. 4-7. The percent-of-sales forecast is only as good as the functional relationship of assets and liabilities to sales. To the extent that past relationships accurately depict the future, the percent-of-sales method will give values that reasonably represent the values derived through the pro-forma statements and the cash budget. 4-8. Estimates of required new funds (RNF) for future years is essential for cash management to plan for new low cost sources of both short and long term funds. Lead time, often months, is required to provide lenders extensive information for increases in loans and to maintain existing loans. Sustainable growth rate (SGR) is an estimate of the level of growth in production and/or sales the company can handle with existing resources. If sales are forecasted to be higher than current capacity, the RNF calculations tells the firm new sources of financing, debt or equity, are required. The combined information of both the RNF and SGR allows management to make strategic financial and operating decisions. 4-9. International Financial Reporting Standards (IFRS) have been implemented in Canada for public companies effective January 1, 2011. The format of the Statements of Financial Position lists the long term assets (usually larger amounts) first and the current assets last. Similarly, the long term liabilities and equity are listed first and current liabilities last. The other three financial statements formats are similar to the previous GAAP. There are numerous differences between IFRS amounts compared to the previous GAAP. The main difference is that accounts are converted from cost basis to current market values as at the year end date. Also, numerous other account differences exist. Private companies have the option of using IFRS but most will use Accounting Standards for Private Enterprises (ASPE) which is easier and less time to prepare. ASPE statements format are similar to previous GAAP statements but amounts will differ from IFRS statements primarily since accounts remain at cost values, although various rules apply for the calculations of various account balances. In theory, the change to IFRS for public companies would make comparisons of financial statements of companies in various countries more effective since the same accounting rules are required resulting in better decision making. Notes to financial statements are more extensive providing more details for the financial analyst. However, the rules allow companies options in applying the rules resulting in different valuations making performance comparisons more difficult and less reliable. You would cover the differences in more detail in accounting courses. 4.10 The results of your research will differ based on locations, time period and industries compared. In general, Canadian economic indicators have more favorable results than most countries in Europe and the U.S. However, with few exceptions, GDP growth and inflation are forecasted to be low but with higher unemployment rates. In conclusion, the global economy will be challenged with significant problems in a changing environment. Internet Resources and Questions 1. www.bmo.com/economic/index.html www.rbccm.com/0,,cid-15911_,00.html Problems 4-1. ER Medical Supplies Unit volume.................... Price................................ Total Sales...................... Returns (5%).................. Net Sales......................... 4-2. 2,000 × 1.25 $160 × 1.10 2,500 $176 $440,000 22,000 $418,000 Eli Lilly Beginning cash − Asset buildup Profit Ending cash $120,000 (320,000) (1/2 × $640,000) 96,000 (8% × $1,200,000) ($104,000) Deficit No. Cash will be in a deficit. 4-3. Eli Lilly (continued) Beginning cash − No asset buildup Profit Ending cash $100,000 0 44,800 (8% × $560,000) $144,800 The lesson to be learned is that increased sales can increase financing requirements and reduce cash even for a profitable firm. 4-4. (1) Outcome A B C 4-5. Gibson Manufacturing Corp. (2) (3) (4) (5) Expected Total Value Probability Units Price Value (2 × 5) .20 100 $20 2,000 400 .50 180 25 4,500 2,250 .30 210 30 6,300 1,890 Total expected value = $4,540 Brampton Truck Parts Outcomes Probability A .20 B .50 C .30 4-6. Units 300 500 1,000 Total Expected Price Value Value $16 4,800 960 25 12,500 6,250 30 30,000 9,000 $16,210 Central Networks Last year sales: 3,000 units x $50 = $150,000 Projected sales: 3,000 x 1.20 increase = 3,600 units Projected sales in dollars: 3,600 units x ($50 x1.10). = $198,000 – returns (6% x $198,000) = $186,120 Net Sales 4-7. 4-8. All Metal Bearings Last year sales: 10,000 units x $20 = $200,000 Projected sales: 10,000 x 1.30 increase = 13,000 units Projected sales in dollars: 13,000 x ($20 - .10 x $20 decrease) = $ 234,000 – returns (3% x $234,000) = $226,980 Net Sales Ross Pro’s Sports Equipment + Projected sales...................... 4,800 units + Desired ending inventory..... 480 (10% × 4,800) − Beginning inventory............. 300 Units to be produced................ 4,980 4-9. Digitex, Inc. + Projected sales.................... + Desired ending inventory........ − Beginning inventory.............. Units to be produced............. 4-10. Hoover Electronics + Projected sales..................... + Desired ending inventory.... − Beginning inventory............ Units to be produced............... 4-11. 60,000 units 6,600 (30% × 22,000) 22,000 44,600 Biomedical Products + Projected sales..................... + Desired ending inventory.... − Beginning inventory............ Units to be produced............... 4-12. 9,000 units (6,000 × 1.50) 450 (5% × 9,000) 200 9,250 80,000 units 18,400 (20% × 92,000) 12,800 (16% × 80,000) 85,600 Wolfson Corporation Cost of goods sold on 700 units (FIFO) 4-13. Old inventory: Quantity (Units)............. Cost per unit................... Total............................... 400 $21 $ 8,400 New inventory: Quantity (Units).............. Cost per unit................... Total................................ 300 $24 $ 7,200 Total Cost of Goods Sold.... $15,600 Higgins Data System a. Cost of goods sold on 1,100 units (LIFO) New inventory: Quantity (Units)............... Cost per unit..................... Total................................. 850 $19 $16,150 Old inventory: Quantity (Units)................ Cost per unit..................... Total.................................. 250 $16 $ 4,000 Total Cost of Goods Sold...... $20,150 b. Cost of goods sold on 1,100 units (FIFO) Old inventory: Quantity (Units)................ Cost per unit...................... Total.................................. 600 $16 $ 9,600 New inventory: Quantity (Units)................. Cost per unit...................... Total................................... 500 $19 $ 9,500 Total Cost of Goods Sold........... 4-14. $19,100 Cox Corporation FIFO Sales (13,000 @ $16)..... Cost of goods sold: Old inventory: Quantity (units)……… 3,000 Cost per unit................ $ 8 Total............................... New inventory: Quantity (units)…….. 10,000 Cost per unit................ $ 9 Total............................... Total cost of goods sold. Gross profit.................... Value of ending inventory: Beginning inventory (3,000 × $8)................. $ 24,000 $208,000 $24,000 90,000 114,000 $ 94,000 + Total production (12,000 × $9)....... ...... Total inventory available for sale.......... − Cost of goods sold....... Ending inventory.......... 108,000 132,000 114,000 $ 18,000 OR: 2,000 units × $9 = $18,000 4-15. Cox Corporation (Continued) LIFO Sales (13,000 @ $16)... $208,000 Cost of goods sold: New inventory: Quantity (units).......... 12,000 Cost per unit............... $ 9 Total............................. $108,000 Old inventory: Quantity (units).......... 1,000 Cost per unit............... $ 8 Total............................. 8,000 Total cost of goods sold 116,000 Gross profit................... $ 92,000 Value of ending inventory: Beginning inventory (3,000 × $8)................ + Total production (12,000 × $9).............. $ 24,000 108,000 Total inventory available for sale......... − Cost of goods sold..... Ending inventory........ 132,000 116,000 $ 16,000 OR: 2,000 units × $8 = $16,000 4-16. Jerrico Wallboard Co. LIFO Sales (31,500 @ $29.60).. $932,400 Cost of goods sold: New inventory: Quantity (units).......... 28,500 Cost per unit............... $ 22.50 Total............................. $641,250 Old inventory: Quantity (units).......... 3,000 Cost per unit............... $ 18.10 Total............................. 54,300 Total cost of goods sold. 695,550 Gross profit.................... $236,850 Value of ending inventory: Beginning inventory (7,000 × $18.10)........ + Total production (28,500 × $22.50)...... Total inventory $126,700 641,250 available for sale......... − Cost of goods sold..... Ending inventory........ 767,950 695,550 $ 72,400 OR: 4,000 units × $18.10 = $72,400 4-17. Power Ridge Corporation FIFO Sales (13,000 @ $16)..... Cost of goods sold: Old inventory: Quantity (units)……… 3,000 Cost per unit................ $ 8 Total............................... New inventory: Quantity (units)…….. 10,000 Cost per unit................ $ 9 Total............................... Total cost of goods sold. Gross profit.................... Value of ending inventory: Beginning inventory (3,000 × $8)................. + Total production $ 24,000 $208,000 $24,000 90,000 114,000 $ 94,000 (12,000 × $9)....... ...... Total inventory available for sale.......... − Cost of goods sold....... Ending inventory.......... 108,000 132,000 114,000 $ 18,000 OR: 2,000 units × $9 = $18,000 4-18. Watt’s Lighting Store Cash Receipts Schedule May Sales Collections(30% of current sales) June July August $33,000 $32,000 $30,000 $36,000 Sept. $25,000 October $34,000 $ 9,000 10,800 7,500 10,200 Collections(40% of prior month's sales) 12,800 12,000 14,400 10,000 Collections(20% of sales 2 months earlier) 6,600 6,400 6,000 7,200 $28,400 $29,200 $27,900 Total cash receipts Still due (uncollected) in December: Bad debts: ($30,000 +36,000 +25,000 +34,000 +42,000 +44,000) × 10% = (211,000) × 10% = $21,100 To be collected from November sales: ($42,000 × .20) = $8,400 $27,400 $ To be collected from December sales: ($44,000 × .60) = $26,400 $21,100 +$8,400 + $26,400 = $55,900 due Expected to be collected: $55,900 due − $21,100 bad debts = $34,800 4-19. Ed’s Waterbeds Cash Receipts Schedule January February Sales Collections(30% of current sales) March April $13,500 $13,000 $12,000 $16,000 May $10,000 June $14,000 $1 3,600 4,800 3,000 4,200 Collections(40% of prior month's sales) 5,200 4,800 6,400 4,000 Collections(20% of sales 2 months earlier) 2,700 2,600 2,400 3,200 $11,500 $12,200 $11,800 Total cash receipts Still due (uncollected) in August: Bad debts: ($12,000 +16,000 +10,000 +14,000 +17,000 +18,000) × 10% = (87,000) × 10% = $8,700 To be collected from July sales: ($17,000 × .20) = $3,400 To be collected from August sales: ($18,000 × .60) = $10,800 $8,700 +$3,400 + $10,800 = $22,900 due Expected to be collected: $22,900 due − $8,700 bad debts = $14,200 4-20. InnerVision, Inc. Cash Payment Schedule $11,400 $1 June July August Sept. October $16,000 $28,800 $28,800 $28,800 $28,800 16,000 28,800 28,800 28,800 Labour 8,000 10,400 8,000 12,000 Fixed overhead 5,000 5,000 5,000 5,000 $29,000 $44,200 $41,800 $45,800 * Purchases **Payment to material purchases Total Cash Payments * Monthly purchases equal ($192,000 ×60%)/ 4 = $115,200/ 4 = $28,800 ** Payment is equal to previous month’s purchases 4-21. Prince Albert Corporation Cash Payment Schedule Dec. Sales Purchases (30% of next month's sales) Jan. Feb. March April May $10,000 $12,000 $14,000 $20,000 $10,000 $3,000 3,600 4,200 6,000 3,000 4,800 Payment (40% of current purchases) 1,440 1,680 2,400 1,200 1,920 Payment (60% of prior month's purchases) 1,800 2,160 2,520 3,600 1,800 Total payment for materials 3,240 3,840 4,920 4,800 3,720 Dec. Labour costs Jan. 4,000 Feb. 4,000 March 4,000 April 4,000 May 4,000 Fixed overhead 2,000 2,000 2,000 2,000 2,000 Interest payments 3,000 Sales commission (1.5% of $82,000) Total payments 4-22. $9,240 $9,840 $13,920 $10,800 Boswell Corporation Production Schedule March April Forecasted unit sales 6,000 8,000 + Desired ending inventory $9,720 $ May 5,500 12,000 8,250 6,000 − Beginning inventory 9,000 12,000 8,250 Units to be produced 9,000 4,250 3,250 Cash Payments February March Units produced Materials ($5/unit) month after production Labour ($10/unit) month of production Fixed overhead Dividends 5,000 April 9,000 4,250 $ 25,000 $ 45,000 90,000 42,500 12,000 12,000 $ March Total cash payments 4-23. April $127,000 May $ 99,500 Ace Battery Company Production Schedule January February March April May Forecasted unit sales 800 650 600 1,100 1,350 +Desired ending inventory 780 720 1,320 1,620 1,800 - Beginning inventory 960 780 720 1,320 1,620 = Units to be produced 620 590 1,200 1,400 Summary of Cash Payments 1,530 Dec. January February March April 600 620 590 1,200 1,400 $ 7,200 $ 7,440 $ 7,080 $14,400 Labour cost ($5/unit) month incurred 3,100 2,950 6,000 7,000 Overhead cost 6,000 6,000 6,000 6,000 Units produced Material cost ($12/unit) month after purchase Interest 8,000 Employee bonuses Total cash payments 4-24. $16,300 $16,390 Warren’s Auto Parts Cash Receipts Schedule September October November $27,080 $27,400 December September October November December Sales $20,000 $25,000 $35,000 $30,000 Credit sales (80%) Cash sales (20%) Collections in month after sales (40%) Collections two months after sale (60%) Total cash receipts 16,000 4,000 20,000 5,000 28,000 7,000 8,000 24,000 6,000 11,200 9,600 12,000 $24,600 $29,200 Cash receipts Cash payments Net cash flow Beginning cash balance Cumulative cash balance Monthly loan or (repayment) Cumulative loan balance Ending cash balance 4-25. Cash Budget November December $24,600 $29,200 28,000 25,000 (3,400) 4,200 6,000 6,000 2,600 10,200 3,400 (3,400) 3,400 −0− $ 6,000 $ 6,800 Jim Daniels Health Products Cash Receipts Schedule November December Sales Credit sales (60%) January February March $200,000 $220,000 $280,000 $320,000 $340,000 120,000 132,000 168,000 192,000 204,000 November December 80,000 88,000 January 112,000 February 128,000 March 136,000 36,000 39,600 50,400 57,600 Collections (two months after credit sales) 70% 84,000 92,400 117,600 Total cash receipts $235,600 $270,800 $311,200 Cash sales (40%) Collections (month after credit sales) 30% Jim Daniels Health Products (continued) Cash Payments Schedule January February March $ 84,000 $ 96,000 $102,000 112,000 128,000 136,000 elling and admin. expense (5% of sales) 14,000 16,000 17,000 verhead 28,000 28,000 28,000 ayments for purchases (30% of next month's sales paid in month after purchases equivalent to 30% of current sales) abour expense (40% of sales) axes 8,000 ividends otal cash payments* 2,000 $246,000 $268,000 $285,000 * The $10,000 of amortization is excluded because it is not a cash expense. Jim Daniels Health Products (Continued) Cash Budget January February March $235,600 $270,800 $311,200 Total cash payments 246,000 268,000 285,000 Net cash flow (10,400) 2,800 26,200 Beginning cash balance 80,000 75,000 75,000 Cumulative cash balance 69,600 77,800 101,200 Monthly loan or (repayment) 5,400 (2,800) (2,600) Cumulative loan balance 5,400 2,600 −0− $ 75,000 $ 75,000 Total cash receipts Ending cash balance 4-26. $ 98,600 Ellis Electronics Cash Receipts Schedule Sales Credit sales (90%) + Cash sales (10%) April May June July Augu $320,000 $300,000 $275,000 $275,000 $290,0 288,000 270,000 247,500 247,500 261,0 32,000 30,000 27,500 27,500 29,0 April May June July 57,600 54,000 49,500 49, + Collections (second month after sale) 80% 230,400 216,000 198, Total cash receipts $311,900 $293,000 $276, + Collections (month after sale) 20% Augu Ellis Electronics (Continued) Cash Payments Schedule April May June July Augu $130,000 $120,000 $120,000 $180,000 $200,0 52,000 48,000 48,000 72,0 78,000 72,000 72,0 Labour expense (10% of sales) 27,500 27,500 29,0 Overhead 12,000 12,000 12,0 Interest payments 30,000 Cash dividend 50,000 Taxes 25,000 $159,500 $185,0 Purchases Payments (month after purchase: 40%) Payments (second month after purchase: 60%) Capital outlay Total cash payments $270,500 Ellis Electronics (Continued) Cash Budget June July August $311,900 $293,000 $276,500 Cash payments.............................. 270,500 159,500 185,000 Net cash flow................................ 41,400 133,500 91,500 Beginning cash balance................ 20,000 50,000 50,000 Cumulative cash balance.............. 61,400 183,500 141,500 Monthly borrowing or (repayment). -- -- -- Cumulative loan balance.............. -- -- -- Marketable securities purchased.. 11,400 133,500 91,500 -- -- Cash receipts............................. (sold) Cumulative marketable securities. 11,400 144,900 236,400 Ending cash balance..................... 50,000 50,000 50,000 *Cumulative marketable securities (August) $236,400 Cumulative cash balance (September) − 254,800 Required (ending) cash balance − 15,000 Monthly borrowing − $ 33,400 4-27. Cholesterol Dairy Products a. Required new funds = A (∆S ) − L (∆S ) − PS2 (1 − D ) S1 S1 ∆S = (10% )($100 million ) ∆S = $10 million 80 ($10 million ) − 15 ($10 million ) − .05 ($110 million )(1 − .35) 100 100 RNF = .80 ($10 million ) − .15 ($10 million ) − .05 ($110 million )(.65) RNF = $8.0 million − $1.5 million − $3.575 million RNF = $2.925 million RNF = The firm needs $2.925 million in external funds. b. Balance Sheet ($ millions) Assets Cash Accounts receivable Inventory Current assets Capital assets Total assets $88.00 c. Current ratio Total debt/ assets 4-28. $5.50 11.00 27.50 44.00 44.00 Liabilities and Shareholders’ Equity Accounts payable $ 7.700 Accrued wages 5.500 Accrued taxes 3.300 Current liabilities 16.500 Long-term debt 22.925 Common stock 25.000 Retained earnings 23.575 Total liabilities and equity $88.000 Year 1 2.67 × 43.75% Year 2 2.67 × 44.80% Longbranch Western Wear Company a. Profit margin = Earnings aftertax $20,000 = = .10 = 10% Sales $200,000 Payout ratio = Dividends $10,000 = = .50 = 50% Earnings $20,000 Change in Sales = 20% × $200,000 = $40,000 Spontaneous assets = Current assets = Cash + Accounts receivable + inventory Spontaneous liabilities = Accounts payable + Accrued (wages + taxes) Required new funds = A (∆S ) − L (∆S ) − PS2 (1 − D ) S1 S1 30 ($40,000) − 8 ($40,000) − .10 ($240,000)(1 − .5) 200 200 RNF = .15 ($40,000 ) − .04 ($40,000 ) − .10 ($240,000 )(.50 ) RNF = $6,000 − $1,600 − $12,000 RNF = ($7,600 ) RNF = b. Balance Sheet Assets Cash $ Accounts receivable Inventory Current assets Capital assets Liabilities and Shareholders’ Equity 6,000 12,000 18,000 36,000 70,000 Accounts payable Accrued wages Accrued taxes Current liabilities Notes payable Long-term debt Common stock Retained earnings $ 6,000 1,200 2,400 9,600 0* 14,400* 20,000 62,000 Total assets $106,000 Total liabilities and equity $106,000 *After the notes payable was reduced , the long-term debt was reduced. c. Year 1 3.75 × 30.0% Current ratio Total debt/ assets 4-29. a. Year 2 3.75 × 22.6% Clyde's Well Servicing Profit margin = Earnings aftertaxes $174,000 = = 8.7% Sales $2,000,000 Payout ratio = Dividends $104,400 = = 60% Earnings $174,000 Change in sales (S) RNF = = 30% × $2,000,000 = $600,000 A (∆S ) − L (∆S ) − PS 2 (1 − D ) S1 S1 $500,000 ($600,000) − $275,000 ($600,000) − .087($2.6 mil )(1 − .6) $2,000,000 $2,000,000 = .25($600,000) – .1375($600,000) – .087($2,600,000) (.4) = $150,000 – $82,500 – $90,480 = − $22,980 RNF = There are excess funds of $22,980. No funds required provided capital assets sufficient. b. Current average collection period = $260,000(365)/ $2,000,000 = 47.45 days With sales of $2,600,000 the accounts receivable balance will be = $2,600,000 × 47.75/365 = $338,000 With sales of $2,600,000 and an average collection period of 43 days, the accounts receivable balance will be = $2,600,000 × 43/365 = $306,301 This represents a decrease in required funds of = $338,000 – $306,301 = $31,699 Therefore required new funding (decrease) = $31,699 + $22,980 = $54,679 This is an excess and could be invested in marketable securities, used to pay down bank loans, or invest in capital assets. c. Income Statement (partial) Sales Gross profit @ 40% Selling, general and administrative expenses Amortization EBIT Interest EBT Taxes @35% Earnings available to common shareholders $2,600,000 1,040,000 450,000 67,500 522,500 40,000 482,500 168,875 $313,625 Dividends Transfer to retained earnings 120,000 $193,625 Balance Sheet ($ thousands) Assets Cash Accounts receivable Inventory Current assets Capital assets Total assets $ 35.0 306.3 260.0 601.3 675.0 $1,276.3 Liabilities and Equity Account payable $136.5 Accruals 20.0 Bank loan 176.2 Current liabilities 332.7 Long-term debt 175.0 Common stock 175.0 Retained Earnings 593.6 Total liabilities & shareholders’ equity $1,276.3 New funds required = $226.3 − $200.1 = $26.2 (the increase in shortterm debt) 4-30. a. Harvard Prep Shops RNF = ΔS A (∆S ) − L (∆S ) − PS 2 (1 − D ) S1 S1 =25% × $300,000,000 = $75,000,000 $210 mil. ($75 mil.) − $90 mil. ($75 mil.) − .15 ($375 mil.)(1 − .3) $300 mil. $300 mil. RNF = .70 ($75 million ) − .30 ($75 million ) − .15 ($375 million )(.7 ) RNF = RNF = $52.5 million − $22.5 million − $39.375 million RNF = −$9,375,000 A negative figure for required new funds indicates that an excess of funds ($9.375 mil.) is available for new investment. No external funds are needed. b. RNF= $52.5 million − $22.5 million − .20($375 mil.) × (1 − .65) = $52,500,000 − $22,500,000 − $26,250,000 = $ 3,750,000 external funds required The net profit margin increased slightly, from 15% to 20%, which decreases the need for external funding. The dividend payout ratio increased from 30% to 65%, necessitating more external financing. The effect of the dividend policy change overpowered the effect of the net profit margin change. Comprehensive Problems 4-31. Mansfield Corporation (External funds requirement) a. Δ Sales= .35 × $100 million = 35 million Spontaneous assets = 5% + 15% + 20% + 40% = 80% Spontaneous liabilities = 15% + 10% = 25% RNF = A (∆S ) − L (∆S ) − PS 2 (1 − D ) S1 S1 RNF = .80 ($35 million ) − .25 ($35 million ) − .10 ($135 million )(1 − .5) RNF = $28 million − $8.75 million − $6.75 million RNF = $12.5 million b. If Mansfield reduces the payout ratio, the company will retain more earnings and need less external funds. A slower growth rate means that fewer assets will have to be financed and in this case, less external funds would be needed. A declining profit margin will lower retained earnings and force Mansfield Corporation to seek more external funds. c. Mansfield Corporation (Continued) Balance Sheet - December 31, 2013 ($ millions) Cash $ 6.75 Accounts payable Accounts receivable 20.25 Accruals Inventory 27.00 Notes payable Net capital assets 54.00 Long-term bonds Common stock Retained earnings $108.00 1 $ 20.25 13.50 19.501 5.00 10.00 39.752 $108.00 Original notes payable plus required new funds. This is the plug figure. 2 2013 retained earnings (beginning of 2013) + PS 2 (1 - D) d. Debt/ assets Debt/ equity Current ratio ROA ROE 2011 46.25% 0.86 × 1.25 × 12.50% 23.26% 2012 53.94% 1.17 × 1.01 × 12.50% 27.14% e. Sustainable growth rate: D   P(1 − D )1 + T  E   SGR = D  A  − P(1 − D )1 + T  S1 E    37 m  .10 (1 − .50) 1 +  43m   SGR (05) = = .1316 or 13.16%  37 m  .80 − 10 (1 − .50) 1 +   43m  4-32.  58.25m  .10 (1 − .50 ) 1 +  49.75m   SGR (06) = = .1570 or 15.70% 58 . 25 m   .80 − 10 (1 − .50) 1 +   49.75m  Adams Corporation (forecasting with seasonal production) December 1,500,000 Projected unit sales +Desired ending inventory (2 months 2,900,000 supply) − Beginning inventory 2,600,000 Units to be produced 1,800,000 January 1,700,000 February 1,200,000 March 1,400,000 2,600,000 3,400,000 4,500,000 2,900,000 1,400,000 2,600,000 2,000,000 3,400,000 2,500,000 Monthly Cash Payments December January February March December January February March Units to be produced 1,800,000 1,400,000 2,000,000 2,500,000 Materials (from previous month) $93,600 $84,000 $120,000 Labour ($20 per thousand units) 28,000 40,000 50,000 Overhead ($10 per thousand units) 14,000 20,000 25,000 Selling & adm. expense (20% of 52,700 37,200 43,400 sales) Interest 8,000 Taxes (40% tax rate) 64,560* Dividends 48,420* Total payments $188,300 $181,200 $359,380 * See the pro forma income statement, which follows this material for the development of these values. Monthly Cash Receipts (Adams Corporation) Nov. Sales Collections (50% of prior month) Collections (50% of 2 months earlier) Total collections Dec. January February March $175,000 $232,500 $263,500 $186,000 $217,000 87,500 116,250 131,750 93,000 87,500 116,250 131,750 $203,750 $248,000 $224,750 Monthly Cash Flow January February March $203,750 $248,000 $224,750 Cash payments 188,300 181,200 359,380 Net cash flow $ 15,450 $ 66,800 $(134,630) Cash receipts Adams Corporation (Continued) Cash Budget January February Net cash flow March $15,450 $66,800 Beginning cash balance 30,000 25,000 Cumulative cash balance $45,450 $91,800 Loans and (Repayments) −0− −0− 47,380 −0− 20,450 −0− 66,800 47,380 (87,250) 20,450 $25,000 87,250 $25,000 −0− $ 25,000 Cumulative loans Marketable securities Cumulative marketable securities Ending cash balance Sales $(134,630) 25,000 ($109,630) Adams Corporation Pro Forma Income Statement January February March Total $263,500 $186,000 $217,000 $666,500 Cost of goods sold 139,400 98,400 126,000 363,800 Gross profit 124,100 87,600 91,000 302,700 January February March Total Selling & administration expense Interest expense 52,700 2,667 37,200 2,667 43,400 2,666 133,300 8,000 Net profit before taxes 68,733 47,733 44,934 161,400 Taxes 27,493 19,093 17,974 64,560 Net profit aftertax Less: Common dividends Increase in retained earnings Material Labour Overhead $ 41,240 $ 28,640 $ 26,960 $ 96,840 48,420 $ 48,420 Cost of Goods Sold Unit Cost per thousand Unit cost per thousand before January 1st after January 1st $52 $60 20 20 10 10 $82 $90 Ending inventory as of December 31 was 2,600,000, therefore, sales for January and February had a cost of goods sold per thousand units of $82, and March sales reflect the increased cost of $90 per thousand units using FIFO inventory methods. Pro forma Balance Sheet (March) Assets Liabilities & equity Current assets: Current liabilities: Cash $ 25,000 Accounts payable Accounts receivable 310,000 Notes payable Inventory 405,000 Long-term debt Plant & equipment: Shareholders' equity: $150,000 47,380 400,000 Net plant 800,000 Common stock Retained earnings Total liabilities & Total assets $1,540,000 shareholders' equity Explanation of changes in the Balance Sheet: Cash = ending cash balance from cash budget in March Accounts receivable = March sales plus 50% of Feb. sales 504,200 438,420 $1,540,000 $217,000 93,000 $310,000 Inventory = ending inventory in March of 4,500,000 units at $90 per thousand Plant and equipment did not change since we did not include amortization. RE = Old RE + (NI - dividends) = $390,000 + ($96,840 - $48,240) = $438,420 4-33. Comprehensive Financial Forecasting Problem Toys For You May June July Nov. Dec. $675.0 $607.5 $585.0 $585.0 $585.0 $585.0 $585.0 $585.0 Payment 450.0 630.0 592.5 585.0 585.0 585.0 585.0 Accounts payable 945.0 900.0 892.5 892.5 892.5 892.5 892.5 Labour 195.0 195.0 195.0 195.0 195.0 195.0 Selling & admin. 254.5 269.1 286.7 307.1 321.8 333.5 Other 375.0 375.0 375.0 375.0 375.0 375.0 Purchases Note payable August Sept. October 675.0 675.0 Interest 270.0 Taxes 338.0 Dividends Total payments 22.5 $1,477.0 22.5 $2,106.6 $1,441.7 $2,092.6 $2,151.8 $1,488.5 Toys For You (Continued) May Cost of goods produced June 1,155.0 July 1,155.0 August 1,155.0 COGS Inventory Sept. 1,155.0 October 1,155.0 Nov. 1,155.0 4,362.8 $8,231.0 $9,386.0 $10,541.0 $7,333.3 Dec. 1,155.0 5,181.8 $8,488.2 $9,643.2 $5,616.5 Toys For You (Continued) * Note: Totals may differ due to rounding May Sales $1,732.5 June $1,845.0 July August Sept. October $1,957.5 $2,070.0 $2,205.0 $2,362.5 1,732.5 1,845.0 1,995.0 1,380.0 Nov. $2,475.0 Dec. $2,565.0 Collections 60 days 50 days 652.5 42 days 1,323.0 0.0 2,299.5 35 days 945.0 2,062.5 Total collections 1,732.5 2,497.5 1,995.0 2,703.0 2,299.5 3,007.5 3,802.5 3,375.0 3,585.0 3,244.5 3,420.0 2,977.5 Receipts 1,732.5 2,497.5 1,995.0 2,703.0 2,299.5 3,007.5 less payments 1,477.0 2,106.6 1,441.7 2,092.6 2,151.8 1,488.5 255.5 390.9 553.4 610.4 147.8 1,519.1 $921.5 $1,312.4 $1,865.8 $2,476.2 $2,623.9 $4,143.0 Accounts receivable 3,577.5 Net receipts Accumulated cash $666.0 Toys For You Ltd. Income Statement September December Sales $6,232.5 $7,402.5 COGS 4,362.8 5,181.8 Gross profit 1,869.8 2,220.8 Selling & administration 810.2 962.3 Amortization 114.0 114.0 Operating profit 945.5 1,114.4 0.0 270.0 Profit before taxes 945.5 874.4 Taxes at 42% 397.1 367.3 $ 548.4 $ 507.2 22.5 22.5 $ 525.9 $ 484.7 Interest Net income Dividends To retained earnings Toys For You Ltd. Projected Balance Sheet June 30 Sept. 30 Dec. 31 Assets Current assets Cash $ 666.0 $ 1,865.8 $ 4,143.0 Accounts receivable 3,578.0 3,585.0 2,977.5 Inventory 8,231.0 7,333.3 5,616.5 12,475.0 12,784.0 12,737.0 Total current assets Capital assets Plant & equipment less accumulated amortization Total assets 11,273.0 11,273.0 11,273.0 4,784.0 4,898.0 5,012.0 6,489.0 6,375.0 6,261.0 $18,964.0 $19,159.0 $18,998.0 Toys For You Ltd. June 30 Sept. 30 Dec.31 Liabilities and Shareholders’ Equity Current liabilities Accounts payable $ 945.0 $ 892.5 $ 892.5 Notes payable 3,700.0 3,025.0 2,350.0 Accrued liabilities 2,596.0 2,596.0 2,596.0 Accrued taxes Total current liabilities 0.0 7,241.0 397.1 6,910.6 426.4 6,264.9 Long term debt 4,725.0 4,725.0 4,725.0 Common stock 4,500.0 4,500.0 4,500.0 Retained earnings 2,498.0 3,023.9 3,508.6 $18,964.0 $19,159.5 $18,998.5 Total liabilities and shareholders’ equity Although current assets have remained about the same, lots of cash has been freed up by tightening credit and drawing down inventories. There is lower investment in accounts receivable and inventories. Comprehensive Financial Forecasting Problem Toys For You (Credit remains at 60 days) May June July $675.0 $607.5 $585.0 $585.0 $585.0 $585.0 $585.0 $585.0 Payment 450.0 630.0 592.5 585.0 585.0 585.0 585.0 Accounts payable 945.0 900.0 892.5 892.5 892.5 892.5 892.5 Labour 195.0 195.0 195.0 195.0 195.0 195.0 Selling &Admin. 254.5 269.1 286.7 307.1 321.8 333.5 Other 375.0 375.0 375.0 375.0 375.0 375.0 Purchases Note payable August Sept. October 675.0 270.0 Taxes 338.0 Total payments 22.5 $1,477.0 Dec. 675.0 Interest Dividends Nov. 22.5 $2,106.6 $1,441.7 $2,092.6 $2,151.8 $1,488.5 Toys For You May Cost of goods produced June July 1,155.0 1,155.0 August 1,155.0 COGS Inventory Sept. 1,155.0 October 1,155.0 Nov. Dec. 1,155.0 1,155.0 4,362.8 $8,231.0 $9.386.0 $10,541.0 $7,333.3 5,181.8 $8,488.2 $9,643.2 $5,616.5 Toys For You (Continued) May Sales $1,732.5 June $1,845.0 July August Sept. October Nov. Dec. $1,957.5 $2,070.0 $2,205.0 $2,362.5 $2,475.0 $2,565.0 1,732.5 1,845.0 1,957.5 2,070.0 2,205.0 2,362.5 1,732.5 1,845.0 1,957.5 2,070.0 2,205.0 2,362.5 $3,802.5 4,027.5 4,275.0 4,567.5 4,837.5 5,040.0 Receipts 1,732.5 1,845.0 1,957.5 2,070.0 2,205.0 2,362.5 less payments 1,477.0 2,106.6 1,441.7 2,092.6 2,151.8 1,488.5 255.5 (261.6) 515.9 (22.6) 53.3 874.1 $921.5 $659.9 $1,175.8 $1,153.2 $1,206.4 $2,080.5 Collections 60 days 50 days 42 days 35 days Total collections Accounts receivable 3,577.5 Net receipts Accumulated cash $666.0 Toys For You Ltd. Income Statement September December Sales $6,232.5 $7,402.5 COGS 4,362.8 5,181.8 Gross profit 1,869.8 2,220.8 Selling & administration 810.2 962.3 Amortization 114.0 114.0 Operating profit 945.5 1,114.4 0.0 270.0 Profit before taxes 945.5 874.4 Taxes at 42% 397.1 367.3 $ 548.4 $ 507.2 22.5 22.5 $ 525.9 $ 484.7 Interest Net income Dividends To retained earnings Toys For You Ltd. Projected Balance Sheet June 30 Assets Sept. 30 Dec. 31 Current assets Cash $ 666.0 $ 1,175.8 $ 2,080.5 Accounts receivable 3,578.0 4,275.0 5,040.0 Inventory 8,231.0 7,333.3 5,616.5 12,475.0 12,784.0 12,737.0 Total current assets Plant & equipment less accumulated amortization Total assets 11,273.0 11,273.0 11,273.0 4,784.0 4,898.0 5,012.0 6,489.0 6,375.0 6,261.0 $18,964.0 $19,159.0 $18,998.0 June 30 Sept. 30 Liabilities and Shareholders’ Equity Dec. 31 Current liabilities Accounts payable $ 945,0 $ 892.5 $ 892.5 Notes payable 3,700.0 3,025.0 2,350.0 Accrued liabilities 2,596.0 2,596.0 2,596.0 0.0 397.1 426.4 Total current liabilities 7,241.0 6,910.6 6,264.9 Long term debt 4,725.0 4,725.0 4,725.0 Common stock 4,500.0 4,500.0 4,500.0 Retained earnings 2,498.0 3,023.9 3,508.6 $18,964.0 $19,159.5 $18,998.5 Accrued taxes Total liabilities and shareholders’ equity Solution Manual for Foundations of Financial Management Stanley B. Block, Geoffrey A. Hirt, Bartley Danielsen, Doug Short, Michael Perretta 9780071320566, 9781259268892, 9781259261015