Chapter 04 - 12th

Chapter 4Financial Planning and Forecasting

CHAPTER 4FINANCIAL PLANNING AND

FORECASTING

ANSWERS TO QUESTIONS:

1. Deferred taxes arise because of the timing difference of some expenses as recorded for financial reporting purposes and these same expenses as recorded for the purpose of making tax filings. For example, most firms use accelerated depreciation for tax purposes and straight-line depreciation for financial reporting. Consequently, taxable income is higher on the company’s public financial statements and “taxes paid” also is higher. Actual taxes paid are determined from a company’s tax filings. The difference between taxes “actually” paid, and taxes shown as being paid on a firm’s public financial statements is recorded as deferred taxes on the right-hand side of the balance sheet.

2. Pro forma financial statements are financial statements that project the results of some assumed events rather than actual events. The assumed events do not necessarily have to be future events; for example, a company considering acquiring another company will usually prepare pro forma statements assuming the two companies had been merged for the past couple of years.

3. The percentage of sales forecasting method is a method of estimating the additional financing that will be needed to support a given future sales level. Financial analysts should be aware that the method assumes that as a company's sales increase, its assets are also assumed to increase proportionately to support the new sales. In addition, the current liabilities that vary directly with sales are also assumed to increase proportionately with the new sales. These assumptions may not hold in many actual financial planning situations.

4. A cash budget is a projection of a company's cash receipts and disbursements over some future period of time. Normally a worksheet is prepared, showing expected receipts and disbursements over the time period. Then, the receipts and disbursements figures (normally, monthly) are combined to determine when the company will require short-term financing and when it will have excess cash.

5. The statement of cash flows can be used to estimate how much external financing a company will need in some future period by estimating the other cash flows of the company for the period.

6. A deterministic model provides a single-number forecast of a financial variable (or variables) without specifying the probability of occurrence of these variables. A probabilistic model generates as output a probability distribution of possible values of the financial variable(s).

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SOLUTIONS TO PROBLEMS:

1. ATCF = EAT + Depreciation + Deferred taxes = $650,000 + $400,000 + $100,000 = $1,150,000

2. Midland Manufacturing CorporationStatement of Cash Flows For the Year Ended December 31, 2010

($ millions)

Cash Flows from Operating Activities:Net income $8.3Adjustments to reconcile net income to net cash provided from operating activitiesDepreciation 9.5(Increase) decrease in current assets or liabilities

Accounts receivable (0.3)Inventories (0.7)Accounts payable 1.5Other current liabilities 2.2

Increase (decrease) in deferred taxes 0.2Total adjustments 12.4

Net cash provided from (used by) operating activities 20.7

Cash Flows from Investing ActivitiesProceeds from sale of facilities or equipment 1.0Capital expenditures ($115.0 - $80.7 + $1.0) (35.3)

Net cash used by investing activities (34.3)

Cash Flows from Financing ActivitiesProceeds from issuance of long-term debt 15.0Repayments of long-term debt (2.0)Dividends paid (3.5)Net cash provided from (used by) financing activities 9.5

Net Increase (Decrease) in Cash (4.1)Cash - Beginning of Year 4.9Cash - End of Year $0.8

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3. a. AdditionalFinancing = [(A/S)(S) - (CL/S)(S)] - [EAT - D]Needed

A = $7,500,000 S = $15,000,000 CL = $1,500,000

S = $3,750,000 D = $250,000

EAT = $18,750,000 - $18,000,000 = $750,000

AdditionalFinancing = [(7,500,000/15,000,000)(3,750,000) - (1,500,000/Needed 15,000,000)(3,750,000)] - [750,000 - 250,000]

= $1,000,000

Balance Sheetas of December 31, 2011

Assets Liabilities

Cash $ 625,000 Accounts payable $1,875,000

Accounts Receivable 2,500,000 Notes payable 2,000,000

Inventories 5,000,000 Total Cur. Liabilities 3,875,000

Total Cur. Assets 8,125,000 Long-term Debt 500,000

Fixed assets, net 1,250,000 Stockholders' equity 5,000,000

Total assets $9,375,000 Total liabilities and $9,375,000

equity

Income Statementfor the Year Ending December 31, 2011

Sales$18,750,000

Expenses, including interest and taxes 18,000,000

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EAT 750,000

Dividends 250,000

Addition to retained earnings $500,000

Selected Financial Ratios

Current ratio 2.10 times

Debt ratio 46.7%

Rate of return on stockholders’ equity 15.0%

Net profit margin on sales (EAT/Sales) 4.0%

Part b. c. Add. Financing Needed $500,000 $800,000

Balance Sheet as of Dec. 31, 2011

Assets

Cash $ 600,000 $ 650,000

Accounts receivable 2,400,000 2,600,000

Inventories 4,800,000 5,200,000

Tot. cur. assets 7,800,000 8,450,000

Fixed assets, net 1,200,000 1,300,000

Total assets $9,000,000 $9,750,000

Liabilities and equity b. c.

Accounts payable $1,800,000 $1,950,000

Notes payable 1,500,000 1,800,000

Tot. cur. liab. 3,300,000 3,750,000

Long-term debt 500,000 500,000

Stockholders' equity 5,200,000 5,500,000

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Total liabilities $9,000,000 $9,750,000 and equity

Income Statementfor Year Ending Dec. 31, 2011

Sales $18,000,000 $19,500,000

Expenses, including interest & taxes 17,050,000 18,250,000

EAT 950,000 1,250,000

Dividends 250,000 250,000Additions to retained earnings $700,000 $1,000,000

Selected Financial Ratios

Current ratio 2.36 2.25Debt ratio 42.2% 43.6%Return on stockholders' equity 18.3% 22.7%Net profit margin on sales 5.28% 6.41%

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4.

Atlas Products Inc.Cash Budget Worksheet

First Quarter, 2010

December January February March

Estimated Sales $825,000 $730,000 $840,000 $920,000Estimated Credit Sales 770,000 690,000 780,000 855,000Estimated Receipts:

Cash sales 40,000 60,000 65,000 Collections of Accounts Receivable

75% of last month’s credit sales 577,500 517,500 585,000 25% of current month credit sales 172,500 195,000 213,750 Total Accounts Receivable collections 750,000 712,500 798,750

Estimated purchases $438,000 504,000 552,000

Estimated payments of accounts payable 438,000 504,000 552,000

Cash BudgetFirst Quarter, 2010

December January February March

Sales $825,000 $730,000 $840,000 $920,000Projected cash balance beginning of month $100,000 $100,000 $100,000

Receipts:Cash sales 40,000 60,000 65,000Collection of accounts receivable 750,000 712,500 798,750

Total cash available $890,000 872,500 963,750

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Disbursements:

Payment of accounts payable $438,000 $504,000 $552,000Wages and salaries 250,000 290,000 290,000Rent 27,000 27,000 27,000Other expenses 10,000 12,000 14,000Taxes 105,000 --- ---Dividends on common stock --- --- 40,000Purchase of new equipment (capital budget) --- 75,000 ---

Total disbursements $830,000 $908,000 $923,000

Excess of available cash over $60,000 ($35,500) $40,750 disbursementsCash loans needed to maintain

balance of $100,000 40,000 135,500 59,250

Projected cash balance, end of month $100,000 $100,000 $100,000

* Purchases are estimated at 60% of next month’s sales.** Payments are estimated to lag purchases by one month

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5. Elmwood Manufacturing Company Cash Budget Worksheet

First Quarter, 2011

December January February March April

Estimated Sales $4,600,000 $6,400,000 $11,200,000 $8,400,000 $7,000,000 (all on credit)

Estimated Receipts60% of last month’s sales -- 2,760,000 3,840,000 6,720,000 --40% of current month’s sales -- 2,560,000 4,480,000 3,360,000 --

Total A/R Collections 5,320,000 8,320,000 10,080,000

Estimated Purchases * 1,920,000 3,360,000 2,520,000 -- --

Estimated Payments** -- 1,920,000 3,360,000 2,520,000

* 30% of next month’s estimated sales** Payments lag purchases by one month

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Cash BudgetFirst Quarter, 2011

December January February March AprilSales $4,600,000 $6,400,000 $11,200,000 $8,400,000 $7,000,000

Projected cashbalance, beginningof month $1,500,000 $750,000 $750,000Receipts: Collection of A/R 5,320,000 8,320,000 10,080,000Total cash available $6,820,000 $9,070,000 $10,830,000

Disbursements Payments of A/P $1,920,000 $3,360,000 $2,520,000 Labor expenses 3,920,000 2,940,000 2,450,000 Factory overhead 650,000 670,000 670,000 Selling and adm. Expenses 1,275,000 1,285,000 1,310,000 Taxes - - 1,600,000 Dividends - - 650,000 Purchase of new equipment - 1,500,000 - Total disbursements $7,765,000 $9,755,000 $9,200,000

Excess of available cash over disbursements ($945,000) ($685,000) $1,630,000

Incremental cash loans needed to maintain a balance of $750,000 $1,695,000 $1,435,000 -Loan repayment 0 0 $880,000Projected cash balance, end of month $750,000 $750,000 $750,000

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6. Podrasky CorporationPro Forma Statement of Cash Flows

($ millions)

Cash Flows from Operating Activities:Net income $80Adjustments to reconcile net income to net cash provided from operating activitiesDepreciation 80(Increase) decrease in current assets or liabilities

Accounts receivable (20)Inventories (20) Total adjustments 40

Net cash provided from (used by) operating activities 120

Cash Flows from Investing ActivitiesCapital expenditures (200)

Net cash used by investing activities (200)

Cash Flows from Financing ActivitiesAdditional financing XRepayments of long-term debt (10)Dividends paid (15)Required increase in cash balance (3)

Net cash provided from (used by) financing activities (28) + X

In this problem, the expected cash flows must equal zero. Therefore,

$120 - $200 - 28 + X = 0

X = $108Therefore, the additional financing required is $108 million.

7. a. A = $2,300,000 S = $4,000,000 S = $2,000,000D = $50,000 EAT = $400,000 CL = $600,000AdditionalFinancing = [(A/S)(S) - (CL/S)(S)] - [EAT - D]Needed = [(2,300,000/4,000,000)(2,000,000) - (600,000/4,000,000)(2,000,000)] - [400,000 - 50,000] = $500,000

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Pro Forma Balance Sheet as of Dec. 31, 2011 Assets LiabilitiesCash $300,000 Accounts Payable $900,000Accounts Receivable 600,000 Notes Payable 1,000,000 Inventories 1,800,000 Long-term Debt 200,000Fixed Assets, net 750,000 Stockholders’ Equity 1,350,000 Total Assets $3,450,000 Total Liabilities and

Stockholders' Equity $3,450,000

b. Projected additional sales are $2,000,000.The required investment in accounts receivable for the projectedsales increase, assuming a 60-day average collection period is $2,000,000 x (60/365) = $328,767The increase in accounts receivable projected in Part a is $200,000. Therefore, a 60-day average collection period will increase the additional financing needed by $328,767 - $200,000 = $128,767

c. Pro forma current ratio = 1.6 1.6 = ($300,000 + $600,000 + $1,800,000)/CL CL = $1,687,500The pro forma current liabilities before any additional financing is$1,400,000 (i.e., A/P = $900,000 and N/P = $500,000). Therefore amaximum of: $1,687,500 - $1,400,000 = $287,500 could be in additional N/P. The remainder of the needed financing would have to be either LTD (possibly secured by the increase in F/A)

or equity.

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8. Table 4-4 ExampleAdditionalFinancing = [(A/S)(S) - (CL/S)S] - (EAT - D]Needed A = $6,500,000 (excluding fixed assets); S = $15,000,000 CL = $1,500,000 D = $250,000

a. S = $3,750,000 EAT = $18,750,000 - $18,000,000 = $750,000 Additional Financing = [(6,500,000/15,000,000)(3,750,000) Needed - (1,500,000/15,000,000)(3,750,000)] - [750,000 - 250,000]

= $750,000

b. S = $3,000,000 EAT = 18,000,000 - 17,050,000 = $950,000 Additional Financing = [(6,500,000/15,000,000)(3,000,000) Needed - (1,500,000/15,000,000)(3,000,000)] - [950,000 - 250,000] = $300,000

c. S = $4,500,000 EAT = 19,500,000 - 18,250,000 = $1,250,000 Additional Financing = [(6,500,000/15,000,000)(4,500,000) Needed - (1,500,000/15,000,000)(4,500,000)]

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- [1,250,000 - 250,000] = $500,000

9. Available funds before capital expansion = EAT plus Tax Depreciation minus Dividends minus Increase in current assets plus Increase in current liabilities minus Reduction in long-term debt = $40 + $18 - $12 - $5 + $2 - $8 = $35Therefore, external financing required is $75 (capital expenditures)

minus $35 (available funds) or $40 million.

10. Sales growth = 50 percentCash growth = +$2Accounts receivable growth = +$5Inventory growth = +$7.5Net fixed asset growth = +$10Accounts payable growth = +$3EAT = $10Dividends = $1

External financing needed = +2 + 5 + 7.5 + 10 - 3 - (10 - 1) = $12.5 million

This amount overstates total financing needs because the problem does not include depreciation information. Financing needs would be reduced by the amount of the expected tax depreciation – a non-cash expense.

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11. No recommended solution

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Chapter 04 - 12th