Chapter 12: Financial Planning and
Forecasting Financial Statements
Discussion
Questions (DQs)
1. Answer Question 12-1 thru 12-7 on pp. 500-501.
2. Submit Problems 12-1 thru 12-9 on pp. 503-505.
12-1 Solution:
Given here,
Growth rate in Sales (g) = 20%
Spontaneous assets (A*) = $3 Million
Spontaneous liabilities (L*) = Accounts
payable + Accruals = $250,000 + $ 250,000 = $500,000
=
$0.5 Million
Sales
in 2010, (S0) = $5 Million
Expected Sales in 2011 (S1) = $6
Million
Working Notes: [S0 (1+g) = $5
Million (1+0.20) = $6 Million]
Therefore,(change in sales), DS =
S1 – S0 = $6 Million – $5 Million = $1 Million
Profit Margin (PM) = Net profit margin/Constant profit
margin = 5%
Payout Ratio (DPR or POR) = 70%
Notes Payable = $500,000
Baxter’s additional funds needed for the
coming year (AFN) =?
Here,
We have formula:
AFN
= (A*/S0) ∆S - (L*/S0) ∆S – PM x S1
(1 - DPR)
= 
$1,000,000 – 
$1,000,000 – 0.05($6,000,000) (1 – 0.7)
$1,000,000 – $1,000,000 – 0.05($6,000,000) (1 – 0.7)
= (0.6)($1,000,000) –
(0.1)($1,000,000) – ($300,000)(0.3)
= $600,000 – $100,000 – $90,000
= $
410,000.
Therefore, Baxter’s additional funds needed
for the coming year (AFN) = $0.41Million where the sales growth is 20% in the
year.
12-2 Solution:
Given, Spontaneous assets (A*) = $4 Million
and,
Other remaining variables taking constant:
AFN
= (A*/S0) ∆S - (L*/S0)∆S – PM x S1(1
- DPR)
= 
$1,000,000 – $1,000,000 – 0.05($6,000,000)(1 – 0.7)
$1,000,000 – $1,000,000 – 0.05($6,000,000)(1 – 0.7)
= (0.8) ($1,000,000) – (0.1)($1,000,000) –
($300,000)(0.3)
= $800,000– $100,000 – $90,000
= $610,000.
Thus,
the additional funds needed for the company’s is $610,000.This AFN is different
from the one calculated in Problem 12-1. In 12-1 extra amount needed for an
asset was less than in 12-2 since assets has been increased by Rs. 1,00,000
(mathematically, 4,000,000 – 3,000,000). As capital intensity ratio (A*/S0)
has been increased AFN also increases in 12-2.
The company’s capital intensity ratio for the
company is:
For problem 12-1, A*/ S0 =
$300,000 / $500,000 = 0.6 and
For problem 12-2, A*/ S0 =
$400,000 / $500,000 = 0.8
Therefore,
from the above Calculation it can be said that company’s capital intensity
ratio is different and higher than that of the intensity ratio in Problem 12-1
showing the company being more capital intensive-it would require a large
increase in total assets to support the increase in sales.
12-3 Solution:
Here given,
Payout Ratio (DPR or POR) = Nil or 0% and all
the other variables or numbers including
Sales remaining as mention in 12-1 are same.
Then, according to the question,
AFN = (A*/S0) ∆S - (L*/S0)
∆S – PM x S1(1 - DPR)
= (0.6) ($1,000,000) - (0.1)($1,000,000) -
0.05($6,000,000)(1 - 0)
= $600,000 - $100,000 - $300,000
= $200,000.
Hence, the required additional funds needed
for the coming year would be $200,000 if
payout ratio is 0%.
This
AFN is different and lower than from the one calculated in Problem 12-1. In
12-3 the company retains excess profit on retained earnings which is (100%
retained) than in 12-1 (30% retained). So, AFN decreases in 12-3 because if
there are more retained earnings in the company then it increases the more
internal source of financing. If internal source is increased then there is
less chances of allocate the fund from the external source. As in question
already mention that there has been retained only 30% in problem 12.1 and in
12.3 the whole percent which is 100% has retained. There only requires less
external fund source in problem 12.3 as compare to problem 12.1 due to higher
difference in retained profit.
12-4 Solution:
Here given,
Sales
in 2010, S0 = $2,000,000
Spontaneous assets, A* = $1,500,000
Notes Payable in 2010 = $200,000; Accounts
Payable in 2010 = $200,000; Accruals in 2010 = $100,000;
Therefore, Spontaneous liabilities, L* =
Accounts Payable + Accruals = $200,000 + $100,000 = $300,000
Profit Margin, PM = 5%
Payout ratio, DPR or POR = 60%.
Then, a sales increment (∆S) that the company
can achieve without having to raise funds externally (AFN = $0); that is, its
self-supporting growth rate = ?
We have,
AFN = (A*/S0)∆S - (L*/S0)∆S –
PM x S1(1 - DPR)
$0
=
∆S –
∆S – 0.05 x S1 (1 – 0.6)
∆S –∆S – 0.05 x S1 (1 – 0.6)
$0 = (0.75) ∆S – (0.15)∆S - 0.05 x S1 (1
- 0.6)
$0 = (0.75 ) ∆S - (0.15)∆S - (0.02)S1
$0 = (0.6)∆S - (0.02)S1
$0 = 0.6(S1 - S0) -
(0.02)S1
$0 = 0.6(S1 - $2,000,000) -
(0.02)S1
$0 = 0.6S1 - $1,200,000 - 0.02S1
$1,200,000 = 0.58S1
$2,068,965.52 = S1.
Therefore,
a company can achieve sales increment of ∆S = S1 - S0 =
$2,068,965.52 – $2,000,000 = $68,965.52 without raising additional funds
externally.
12-5 Solution:
Total
Assets or Spontaneous assets 2010, (A*) = $1.2 Million
Accounts Payable, 2010 = $375,000.
Existing Sales, 2010, (S0) = $2.5
Million
Sales Growth (g) = 25%
Expected Sales, 2011 (S1) = S0(1+g)
= $2.5 Million(1+0.25) = $3.125 Million
Spontaneous
liabilities, 2010 (L*) = Accounts payable = $375,000 = $0.375 Million
And, DS = S1 – S0 =
$3.125 Million – $2.5 Million = $0.625 Million
Common Stocks, 2010 = $425,000;
Retained Earnings, 2010 = $295,000
New Common Stocks, 2011 = $75,000
Profit Margin on sales (PM) = 6%
Payout Ratio (DPR or POR) = 40%
Bertin’s Total Long-Term Debt and Total
Liabilities in 2010 =?
New long-term debt financing to be needed in
2011 =?
a)
From the Accounting Equation is:
Total
Assets in 2010 = Total Debt in 2010 + Total Equity in 2010 (Common Stocks +
Retained Earnings)
$1,200,000
= Total Debt + ($425,000 + $295,000)
Thus,
Total Debt = $1,200,000 – $720,000 = $480,000.
And
we know, Total Debt = Current Liability (Account Payable only) + Long-Term Debt
Thus,
Long-Term Debt = Total Debt – Account Payable = $480,000 – $375,000 = $105,000.
Or,
$1,200,000 = $375,000 + Long-term debt +
$425,000 + $295,000
Long-term debt = $105,000.
And, Total debt = Accounts payable + Long-term
debt
= $375,000 + $105,000 = $480,000.
(b) Again,
We know that,
AFN = (A*/S0) ∆S - (L*/S0)
∆S – PM x S1(1 - DPR)
= 
$625,000 – 
$625,000 – 0.06($3,125,000)(1 – 0.4)
$625,000 – $625,000 – 0.06($3,125,000)(1 – 0.4)
=
(0.48) ($625,000) – (0.15) ($625,000) – 0.06 x ($3,125,000)(0.6)
=
$300,000– $93,750 – $112,500
=
$93,750
Then, we get
Therefore, New long-term debt for 2011 =
AFN−New stock for 2011 = $93,750 – $75,000 = $18,750
12-6 Solution:
According to question,
We have,
Existing Sales in 2010, S0 = $1,000
Expected Sales in 2011, S1 =
$2,000
Capacity Utilization of fixed assets during
2010 = 50%
Profit Margin, PM = 5%
Payout Ratio, DPR = 60%
Booth’s additional funds needed (AFN) for the
coming year 2011 =?
We have,
Forecasted Balance Sheet for the year ending
2011:
|
Assets
|
Amount
|
|
Cash [($100/1000) x 2000]
|
$200
|
|
Accounts receivable [(200/1000) x 2000]
|
400
|
|
Inventories [(200/1000) x 2000]
|
400
|
|
Net fixed assets
|
500
|
|
Total assets
|
$1,500
|
|
Capital and Liabilities
|
Amount
|
|
Accounts payable [($50/1000) x 2000]
|
$100
|
|
Notes payable (150 + 360)
|
510
|
|
Accruals [(50/1000) x 2000]
|
100
|
|
Long-term debt
|
400
|
|
Common stock
|
100
|
|
Retained earnings (250 + 40)
|
290
|
|
Total liabilities and equity
|
$1,140
|
|
Additional Fun Needed (AFN)
|
$360
|
Therefore, if a fixed asset has been utilized
at 50% capacity and sales increases by 100%, the AFN is $360.
Here, we assume that additional fund needed
is financed by short-term bank loan, so it is reflected in Notes Payable as:
Additional fund needed (AFN) through notes
payable = New notes payable - old notes
payable
= New notes payable -
old notes payable
= $510 - $150 = $360.
Where,
Full Capacity Sales = 
= $1,000/0.5 = $2,000.
= $1,000/0.5 = $2,000.
Target Fixed Assets to Sales ratio = 
= $500/$2,000 = 0.25.
= $500/$2,000 = 0.25.
Target
Fixed Assets = 0.25($2,000) = $500 = Required FA. Since the firm currently has $500 of fixed
assets, no new fixed assets will be required.
Therefore, addition to Retained Earnings = PM
x (S1) (1 – DPR) = 0.05($2,000)(1 – 0.6) = $40.
12-7 Solution:
Sales for 2010, S0 =
$350 Million
Net Income for 2010, NI = $10.5 Million
Profit Margin, PM = 3% or 0.03
Dividend Paid = $4.2 Million
Payout ratio, DPR = 40% or 0.4,
Tax rate, T = 40% or 0.4,
If Company operating at full capacity then,
(a)
If sales are projected to increase by $70 Million (DS), or 20% (g), the sales for 2011, S1
= $350 Million + $70 Million = $420 Million.
Then, Upton’s projected external
capital requirements using AFN equation is:
AFN
= (A*/S0) (DS) – (L*/S0) (DS) – PM
x S1(1 – DPR)
=
($70) - 
($70) – 0.03 ($420)(1 – 0.4) [Figures in Millions] = $13.44 Million.
($70) - ($70) – 0.03 ($420)(1 – 0.4) [Figures in Millions] = $13.44 Million.
Where,
Spontaneous assets 2010, (A*) = $3.5 M + $26
M + $58 M + $35 M = $122.5 Million
Sales Growth (g) = 20%
Spontaneous liabilities, 2010 (L*) = Accounts
payable + Accruals = $9 M + $8.5 M = $17.5 Million
And, DS = $70 Million
(b)
Using the AFN equation, the required Upton’s self-supporting growth rate
is calculated as:
We know, g = [PM (1 – POR) x So] / [A0* – L0*
- PM (1–POR) x S0]
= [0.03(1 – 0.4) x $350] / [$122.5 – $17.5 –
0.03 (1 – 0.40) x $350] {Figures in Millions}
= 6.38%.
Therefore, the maximum growth rate the firm
can achieve without having to employ non spontaneous external funds, g = 6.38%
(c)
Upton
Computers
Forecasted
Balance Sheet
December
31, 2007
(Millions
of Dollars)
|
Assets
|
Amount
|
|
Cash [(3.5/350 x 100) x 4.2]
|
$4.20
|
|
Receivables [(26/350 x 100) x 4.2]
|
31.2
|
|
Inventories [(58/350 x 100) x 4.2]
|
69.6
|
|
Total current assets
|
$105
|
|
Net fixed assets [(35/350 x 100) x 4.2]
|
42
|
|
Total assets
|
$147
|
|
Liabilities and Equity
|
Amount
|
|
Accounts payable [($9/350 x 100) x 4.2]
|
$10.80
|
|
Notes payable (18 + 13.44)
|
31.44
|
|
Accruals [( 8.5/350 x 100) x 4,2]
|
10.2
|
|
Total current liabilities
|
$52.44
|
|
Mortgage loan
|
6
|
|
Common stock
|
15
|
|
Retained earnings (66 + 7.56*)
|
73.56
|
|
Total liabilities and equity
|
$147.00
|
|
AFN
|
$13.44
|
Where,
*PM = $10.5 M / $350 M = 3%.
Payout = $4.2 M / $10.5 M = 40%.
NI = $350 ´ 1.2 ´ 0.03 = $12.6.
Addition to RE = NI - DIV = $12.6 -
0.4($12.6) = 0.6($12.6) = $7.56.
Here, we can assume that additional fund
needed is financed by short-term bank loan, and hence, it is reflected in Notes
Payable. Hence, the required amount of notes payable reported on the 2011
forecasted balance sheets is = $31.44 Millions.
Or, Additional fund needed (AFN) through notes payable = New notes payable - old
notes payable
New
notes payable = Additional fund needed (AFN) + old notes payable
= $13.44 M + $18.0 M = $31.44
Millions.
12-8 Solution:
a)
Given, sales growth (g) = 15%;
Interest rate on debt = 10%
Here, we have Forecasted
Income Statement:
Stevens Textiles
Forecasted
Pro Forma Income Statement
December
31, 2011
(Thousands
of Dollars)
|
2010
|
Forecast
Basis
|
Pro Forma
2011
|
|
|
Sales
|
$36,000
|
1.15 x Sales10
|
$41,400
|
|
Less: Operating costs (O.C)
|
$32,440
|
1.15 x O.C10
|
37,306
|
|
Earnings before interest and taxes
|
$3,560
|
$4,094
|
|
|
Less: Interest
|
460
|
0.10 x Debt10
|
560
|
|
Earnings before taxes
|
$3,100
|
$3,534
|
|
|
Less: Taxes (40%)
|
1,240
|
1,414
|
|
|
Net income (NI)
|
$1,860
|
$2,120
|
|
|
Dividends (45%)
|
$837
|
$954
|
|
|
Addition to Retained Earnings
|
$1,023
|
$1,166
|
Where,
Debt10 = Notes Payable + Mortgage bonds = $2,100 + $3,500
= $5,600
Addition to Retained Earnings = NI - Dividend = $1,860 -
$837 = $1,023
Hence, from the above forecasted financial statements, the
required Additional Fund Needed (AFN) = $2,128.
Here, we assume that additional fund needed is financed by short-term bank
loan, so it is reflected in Notes Payable.
Notes payable can be
calculate by:
Additional fund needed
(AFN) through notes payable = New notes
payable - old notes payable
= New notes payable - old notes payable
= $4,228 - $2,100 =
$2,128.
And the total assets (TA) = $33,534.
b)
Forecasted Balance Sheet:
Stevens Textiles
Pro
Forma Balance Sheet
December
31, 2011
(Thousands
of Dollars)
[Forecast
[Pro Forma
Basis %
After
[2010] 2011 Sales] [Additions] [Pro Forma] [Financing] Financing]
Cash $
1,0800 0.0300 $1,242 $ 1,242
Accts receivable 6,480 0.1883 7,452 7,452
Inventories 9,000 0.2005
10,350 10,350
Total current Assets $16,560
$19,044 $19,044
Fixed assets
12,600 0.3500 14,490 14,490
Total assets $29,160 $33,534 $33,534
Accounts payable $ 4,320 0.1200 $ 4,968 $
4,968
Accruals 2,880 0.0800
3,312 3,312
Notes payable 2,100 2,100 +2,128
4,228
Total current liabilities $
9,300 $10,380 $12,508
Long-term debt 3,500 3,500
3,500
Total debt $12,800 $13,880 $16,008
Common stock 3,500 [(I/S) 3,500 3,500
Retained earnings 12,860 1,166* ] 14,026 14,026
Total liabilities & equity $29,160 $31,406 $33,534
Additional Fund Needed $ 2,128
Therefore, the resulting total forecasted amount of Notes Payable = $4,288.
c.
Suppose, if the new debt is added throughout the year instead of adding
at the end of the year, then this change definitely affects the answers to
parts (a) & (b). This is because interest expense on debt at end of
year will over-estimate interest
expense if debt is added throughout the year instead of all on January 1.
Hence, more debt causes more interest, which reduces net income, which reduces
retained earnings, which causes more debt. Basing
interest expense on debt at beginning of year will under-estimate interest expense if debt is added throughout
the year instead of all on December 31. But it doesn’t cause problem of
circularity. Basing interest expense on average of beginning and ending debt will accurately estimate the interest
payments if debt is added smoothly throughout the year. But it has the problem of
circularity. A solution that balances accuracy and complexity is to base interest expense on beginning
debt, but use a slightly higher interest rate.
12-9 Solution:
Given, sales growth (g) = 10%
Interest rate on debt = 13%
Given in the question,
|
2010
|
Forecast
Basis
|
Pro Forma
2011
|
|
|
Sales
|
$3,600,000
|
1.10 x Sales10
|
$3,960,000
|
|
Less: Operating costs (O.C)
|
3,279,720
|
1.10 x O. C10
|
3,607,692
|
|
Earnings before interest and taxes
|
$ 320,280
|
$ 352,308
|
|
|
Less: Interest
|
18,280
|
0.13 x Debt10
|
20,280
|
|
Earnings before taxes
|
$ 302,000
|
$ 332,028
|
|
|
Less: Taxes (40%)
|
120,800
|
132,811
|
|
|
Net income (NI)
|
$
181,200
|
$
199,217
|
|
|
Dividends (45%)
|
$ 108,000
|
$ 112,000
|
|
|
Addition to Retained Earnings
|
$73,200
|
$87,217
|
Where,
Debt10 = Notes Payable = $156,000
Addition to Retained Earnings = NI - Dividend = $181,200 - $108,000 = $73,200
Garlington
Technologies Inc.
Pro
Forma Balance Statement
December
31, 2011
Forecast
Basis
%
AFN With AFN
2010 2011 Sales Additions 2010 Effects
2011
Cash $180,000
0.05 $198,000 $198,000
Receivables 360,000
0.10 396,000 396,000
Inventories 720,000
0.20 792,000
792,000
Total current assets $1,260,000 $1,386,000
$1,386,000
Fixed assets 1,440,000 0.40
1,584,000 1,584,000
Total assets $2,700,000 $2,970,000
$2,970,000
Accounts payable $360,000 0.10 $396,000 $396,000
Notes payable 156,000 156,000
+128,783 284,783
Accruals 180,000 0.05 198,000
198,000
Total current liabilities $696,000 $750,000
$878,783
Common stock 1,800,000 [(I/S) 1,800,000 1,800,000
Retained earnings 204,000 87,217*]
291,217 291,217
Total liability & equity $2,700,000 $2,841,217 $2,970,000
Additional Fund Needed (AFN): $128,783
Hence, from the above forecasted financial
statements, we got the required Additional Fund Needed (AFN) = $128,783 for the company. We had assumed that
additional fund needed is financed by short-term bank loan, so it is reflected
in Notes Payable.
Or,
Additional fund needed (AFN) through notes
payable = New notes payable - old notes
payable
= New notes payable - old
notes payable
= $284,783 - $156,000
= $128,783.
Also, the required Notes Payable = $284,783.
References
C.
Paramasivan, T. Subramanian. (2015). Financial Management. New Delhi:
New Age International Publishers.
Brigham, F. E., & Ehrhardt, M.C.(2011). Financial management: Theory and practice.
South-western Cengage Learning: Nelson Education Ltd.
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