Financial+Planning+and+Forecasting+-Solutions-Solutions

Financial Planning and Forecasting - Solutions

1.

The capital intensity ratio can be defined as the level of assets needed to support a given level of sales, and we might expect to observe differences in this ratio between different industries.

*

A. B.

2.

Holding all other factors constant, such as interest expense and dividends, an increase in the cost of goods sold should increase a firm’s need for additional capital.

*

A. B.

3.

Errors in the sales forecast can be offset by similar errors in costs and income forecasts. Thus, as long as the errors are not large, sales forecast accuracy is not critical to the firm.

* 4.

* 5.

* 6.

*

A. B.

True False

True False

True False

The term "spontaneously generated funds" generally refers to increases in the cash account that result from growth in sales, assuming the firm is operating with a positive profit margin. A. B.

True False

Additional funds needed are typically raised from some combination of notes payable, accounts payable, accruals, long-term bonds, and common stock. We can consider these accounts to be non-spontaneous, since they require an explicit financing decision by the form to increase them. A. B.

True False

The net present value (NPV) method assumes that intervening cash flows will be reinvested at the risk-free rate, while the internal rate of return (IRR) method assumes that intervening cash flows will be reinvested at the firm’s cost of capital. ca pital. A. B.

True False

Old Exam Questions - Financial Planning and Forecasting - Solutions

Page 1 of 57 Pages

7.

An increase in the firm's inventory balance will normally require additional financing unless the increase is matched by an equally large decrease in some other asset account.

*

A. B.

8.

To determine the amount of additional funds needed, you may subtract the expected increase in liabilities (a source of funds) from f rom the sum of the expected increases in retained earnings and assets (both uses of funds).

*

1.

A. B.

True False

True False

Which of the following statements concerning percent of sales forecasting is most correct. A. B.

C.

D.

Simply due du e to its mathematical mathema tical basis, the equation eq uation model for percent of sales forecasting will produce a more accurate forecast than a s preadsheet model. As long as the firm is currently operating at full capacity, fixed assets should be set as a constant percent of sales, even if they may be somewhat lumpy in reality. Although the firm may exhibit economies of scale, the percentages that we observe for individual assets (such as cash, inventory, fixed assets, etc.) will not vary over time as the sales of the firm change. A disadvantage of the spreadsheet model is that it is not easy to include changes in a firm’s profit margin, changes in its dividend policy, planned acquisitions of assets, or repayments of liabilities. liabilities. Determining additional funds needed (AFN) may require an iterative solution, since financing charges may lead to circular relationships: income statement determines additions to the balance sheet, which determines funding needs, which determine financing charges, which determines the income statement, and so on.

*

E.

2.

Select the statement that is most correct. A. B.

*

C.

If a firm f irm forecasts forecas ts a large lar ge need for additional add itional funds fu nds needed, nee ded, a good strategy stra tegy to to raise the capital is to increase the dividend payout rate. Suppose a firm is operating its fixed assets below 100 percent capacity (and assuming that it cannot sell or lease these assets) but is at 100 percent with respect to current assets. assets. If sales grow, the the firm can offset the needed increase in current assets simply by switching production to its idle fixed assets. Additional funds needed are typically raised from some combination of notes payable, long-term long-term bonds, and common stock. These accounts accounts are nonspontaneous in that they require an explicit financing decision to increase them.


Page 2 of 57 Pages

7.

An increase in the firm's inventory balance will normally require additional financing unless the increase is matched by an equally large decrease in some other asset account.

*

A. B.

8.

To determine the amount of additional funds needed, you may subtract the expected increase in liabilities (a source of funds) from f rom the sum of the expected increases in retained earnings and assets (both uses of funds).

*

1.

A. B.

True False

True False

Which of the following statements concerning percent of sales forecasting is most correct. A. B.

C.

D.

Simply due du e to its mathematical mathema tical basis, the equation eq uation model for percent of sales forecasting will produce a more accurate forecast than a s preadsheet model. As long as the firm is currently operating at full capacity, fixed assets should be set as a constant percent of sales, even if they may be somewhat lumpy in reality. Although the firm may exhibit economies of scale, the percentages that we observe for individual assets (such as cash, inventory, fixed assets, etc.) will not vary over time as the sales of the firm change. A disadvantage of the spreadsheet model is that it is not easy to include changes in a firm’s profit margin, changes in its dividend policy, planned acquisitions of assets, or repayments of liabilities. liabilities. Determining additional funds needed (AFN) may require an iterative solution, since financing charges may lead to circular relationships: income statement determines additions to the balance sheet, which determines funding needs, which determine financing charges, which determines the income statement, and so on.

*

E.

2.

Select the statement that is most correct. A. B.

*

C.

If a firm f irm forecasts forecas ts a large lar ge need for additional add itional funds fu nds needed, nee ded, a good strategy stra tegy to to raise the capital is to increase the dividend payout rate. Suppose a firm is operating its fixed assets below 100 percent capacity (and assuming that it cannot sell or lease these assets) but is at 100 percent with respect to current assets. assets. If sales grow, the the firm can offset the needed increase in current assets simply by switching production to its idle fixed assets. Additional funds needed are typically raised from some combination of notes payable, long-term long-term bonds, and common stock. These accounts accounts are nonspontaneous in that they require an explicit financing decision to increase them.


Page 2 of 57 Pages

D. E.

3.

If a firm retains all of its earnings, then it will not need any additional funds to support sales growth. None of the statements above is correct.

Considering each action independently and holding other things constant, which of the following actions would reduce a firm's need for additional capital?

*

A. B. C. D. E.

4.

Which of the following statements is least correct (most incorrect)? A.

B.

C.

D.

An increase incre ase in the th e dividend payout ratio. r atio. A decrease in the profit margin. A decrease in the days sales outstanding. An increase in expected sales growth. A decrease in the accrual accounts (accrued wages and taxes).

A firm can c an use regressio re gression n analysis for specific sp ecific item forecasting, forecast ing, such as inventory. However, regression analysis analysis can also be used in in conjunction with the Capital Asset Pricing Model (CAPM) to determine the required rate of return on a firm’s stock: that is, we can use regression analysis to calculate a stock’s “beta” coefficient. One of the advantages of using the spreadsheet model to calculate a firm’s AFN is that t hat it is easier ea sier to incorporate incorpora te such things as a s economies econo mies of scale scal e and lumpy assets than when using the equation model. Financial forecasts should consider the effect of inflation on future prices. Unfortunately, simply observing that total dollar sales ar e expected to increase in the future does not mean that planners have included the effect of inflation on future prices. The increase in in dollar sales could simply simply be due to the fact fact that more units will be sold, not that each unit will be sold at a higher price. One way of looking at percent of sales forecasting is in terms of sources and uses of funds. Percentage of sales forecasting forecasting can tell us us how much assets are expected to increase increase in the future. However, this increase in in assets is a use of funds that must must be offset by a source of of funds. Some of the funds may come from spontaneously increasing increasing liabilities. liabilities. Some of the funds may come from additions to the the firm’s retained earnings. earnings. The remaining funds are additional funds needed and their source is determined by management. Certain liabilities liabilities generally increase spontaneously with sales. These would include any of the firm’s current liabilities, such as accounts payable, notes payable, accruals, and capital leases, but would not include long-term liabilities such as long-term debt or even equity.

*

E.

5.

Which of the following statements is most correct? A.

Any forecast for ecast of financial requirements require ments involves inv olves determining det ermining how much m uch money mo ney the firm will need and is obtained by adding together increases in assets and spontaneous liabilities liabilities and subtracting operating income.


Page 3 of 57 Pages

B.

C. *

D.

E.

6.

Which of the following statements is most correct? A. B. C.

*

D.

E.

7.

B. C. D. E.

8.

If the capital intensity inten sity ratio rati o is high, this per mits sales to grow more rapidly ra pidly without much outside capital. The lower the profit margin, the lower the additional funds needed because less assets are needed to support existing sales. When positive economies of scale are present, linear balance sheet relationships no longer hold. As sales increase, increase, a proportionately greater stock stock of assets is required to support the higher sales level. Technological considerations often require firms to add fixed assets in large, discrete units. units. Such assets are called called lumpy assets and they affect the firm’s financial requirements through the fixed assets/sales ratio at different sales levels. The percent of sales method accounts for changing balance sheet ratios and thus, cyclical changes in the actual sales to assets ratio do not have an impact on financing requirements.

Which of the following statements is incorrect (least correct)? A.

*

The percent of sales method of forecasting financial needs requires only a forecast of the firm’s firm’s balance sheet. Although a forecasted income income statement helps clarify the need, it is not essential to the percent of sales method. Because dividends are paid after taxes from retained earnings, dividends are not included in the percent of sales method of forecasting. Financing feedbacks describe the fact that interest must be paid on the debt used to help finance AFN and dividends must be paid on the shares issued to raise the equity part part of the AFN. These payments would lower the net income and retained earnings shown in the projected financial statements. statements. None of the statements above is correct.

When using us ing regr ession analysis an alysis on historical data to t o determine determ ine a security’s sec urity’s beta, the returns for the security (dependent variable) are regressed against the returns for the market (independent (independent variable). The resulting slope slope coefficient is equal to beta. Just because a stock has a negative beta does not necessarily mean that its expected return must also be negative. The slope of the security market line defines the degree of investors’ risk aversion. If investors become more risk averse, the slope slope of this line will increase. If you add enough randomly selected stocks to a portfolio, you can completely eliminate all of the “market risk” from the portfolio. It is quite simple to convert a variance/covariance matrix into a correlation matrix, since all the data that is needed to do th is is already embedded within the variance/covariance matrix.

Which of the following statements is most correct?


Page 4 of 57 Pages

A. B.

C. *

D.

E.

9.

*

10.

Considering each action independently and holding all other factors constant, which of the following actions would increase a firm's need for additional capital? A. B. C. D. E.

B. C.

D.

E.

1.

A decreas e in the firm’s dividend divi dend payout pa yout ratio. rat io. An increase in the cost of goods sold. A decease in the firm’s total assets outstanding A decrease in the expected sales growth An increase in the firm’s accounts receivable turnover.

Select the statement that is most correct. A.

*

Since accounts acc ounts pay able and accruals accru als must eventually eventu ally be paid, pai d, as these the se accounts increase, AFN also increases. Suppose a firm is operating its fixed assets below 100 percent capacity but is at 100 percent capacity capacity with respect to current assets. assets. If sales grow, grow, the firm can offset the needed increase in current assets with its idle fixed assets capacity. If a firm retains all of its earnings, then it will not need any additional funds to support sales growth. Additional funds needed are typically raised from some combination of notes payable, long-term long-term bonds, and common stock. These accounts accounts are nonspontaneous in that they require an explicit financing decision to increase them. All of the statements above are false.

U.S. Treasury Tr easury Bonds, Bo nds, banker’s ba nker’s acc eptances, and commercial c ommercial paper are a re all examples of capital market instruments. If the maturity risk premium (MRP) is greater than zero, then the yield curve must be upward sloping. Additional funds needed are best defined as the amount of cash generated in a given year minus the amount of cash needed to finance the additional capital expenditures and working capital needed to support the firm’s growth. The percent of sales method is based on the assumptions that most balance sheet accounts are tied directly to sales and that the current level of total assets is optimal for the c urrent sales level. The yield on a 3-years corporate bond will always exceed the yield on a 2-year corporate bond.

You have been given the attached information for your company.

Sales Operating Costs EBIT Interest

2002 Actual $5,000.00 -$3,500.00

2003 Forecast

$1,500.00 -$200.00


Page 5 of 57 Pages

EBT Taxes (40%) Net Income Number of Shares Outstanding

$1,300.00 -$520.00 $780.00 1,000

Total Dividends

$500.00

Addition to RE

$280.00

Current Assets Net Fixed Assets Total Assets A/P and Accruals

2002 Actual $5,000.00 $2,500.00

1,000

2003 Forecast

$7,500.00 $500.00

Debt

$2,000.00

Common Stock

$1,000.00

Retained Earnings

$5,000.00

Total Liability and Equity

$7,500.00

Additional Funds Needed Now make the following assumptions for 2003: 1. 2. 3. 4. 5.

6. 7.

Sales will grow by 15 percent in 2003. Cost of Good Sold will decrease to 68% of sales. The firm has already made plans to increase its debt on the first day of 2003 to $3,000 from its current level of $2,000 (an additional $1,000). The interest rate on debt will remain at 10 percent. The firm’s net fixed assets are currently at full capacity and the firm expects to add additional net fixed assets of $1,000 (you may ignore depreciation expense). Current assets and current liabilities may be expressed as a percentage of sales. The number of shares is expected to remain constant but the dividend is expected to increase to $0.55 per share in 2003.

You should now be able to do a first pass and determine the additional funds needed (AFN). Remember that dividends are paid out of retained earnings, so increasing or decreasing the dividend payment will affect the amount of retained earnings and, therefore, the additional funds needed. What would the dividend per share have to be so that the additional funds needed are z ero? A. B. C. D.

$1.149 / share $1.099 / share $1.199 / share $1.049 / share


Page 6 of 57 Pages

*

E.

$1.249 / share 2002 Actual $5,000.00

2003 Forecast $5,750.00

-$3,500.00

-$3,910.00

EBIT Interest

$1,500.00 -$200.00

$1,840.00 -$300.00

EBT Taxes (40%)

$1,300.00 -$520.00

$1,540.00 -$616.00

$780.00

$924.00

1,000

1,000

Total Dividends

$500.00

$550.00

Addition to RE

$280.00

$374.00

2002 Actual $5,000.00 $2,500.00

2003 Forecast $5,750.00 $3,500.00

$7,500.00

$9,250.00

$500.00

$575.00

Debt

$2,000.00

$3,000.00

Common Stock Retained Earnings

$1,000.00 $5,000.00

$1,000.00 $5,374.00


$7,500.00

$9,949.00

Sales Operating Costs

Net Income Number of Shares Outstanding

Current Assets Net Fixed Assets Total Assets A/P and Accruals

Additional Funds Needed

-$699.00

Firm needs to increase its dividend (reduce retained earnings) by $ 699: New Dividend = $550 + $699 = $1,249 Dividend Per Share = $1,249 / 1,000 = $1.249 / share

2.

Assume that you observe the following percentage returns (in decimal form) for the Market and for Firm A. Use regression analysis to determine how the returns for Firm A are related to the returns for the Market (determine the intercept and slope, setting the Market as the independent variable and Firm A as the dependent variable), then calculate the best guess for what the returns on Firm A will be in 2003, if the return on the market in 2003 is 8 percent (0.08). Note: You must use your financial calculator. You cannot calculate the slope using rise/run. Year

Market

Firm A


Page 7 of 57 Pages

2002 2001 2000 1999 1998 *

- .10 .15 .20 .30 .28

A. B. C. D. E.

-.25 .00 .30 .64 .40

4.45% 5.05% 5.25% 4.65% 4.85%

Do the following on your HP-10BII .10 .15 .20 .30 .28 0

+/- Input Input Input Input Input

y,m ! SWAP .08 ! y,m !

.25 .00 .30 .64 .40

+/- !+ !+ !+ !+ !+

-0.116929791 (intercept) 2.017649341 (slope) 0.044482157 (forecast) = 4.45%

Alternatively, 4.45% = 0.0445 = -.116929791 + (.08)(2.017649341) = -.116929791 + .161411947

YOU ARE GIVEN THE FOLLOWING INFORMA TION FOR PROBLEMS 3 - 4: Income Statement Sales Operating Costs

Year 2 $1,200.00 -$1,020.00

Depreciation

-$55.00

EBIT

$125.00

Interest

-$25.00

EBT

$100.00

Taxes (40%)

-$40.00

Net Income

$60.00

Dividends

$40.00

Assets

Year 2


Year 3 First Pass $1,800.00

Year 3

Year 3 Second Pass $1,800.00

Year 3

Page 8 of 57 Pages

Cash

First Pass

Second Pass

Year 3 First Pass

Year 3 Second Pass

$15.00

Accounts Receivable

$200.00

Inventories

$250.00

Current Assets Gross Plant & Equipment Less: Depreciation Net Plant & Equipment Total

$465.00 $1,100.00 -$555.00 $545.00 $1,010.00

Liabilities & Equity Accounts Payable Notes Payable Accruals

Year 2 $120.00 $50.00 $80.00

Current Liabilities Long-Term Debt Common Stock

$250.00 $210.00 $382.00

Retained Earnings

$168.00

Total

$1,010.00

AFN

N/A

You are also given the following assumptions: 1. 2. 3. 4. 5. 6.

7.

8. 9. 10.

Sales will increase by half (50 percent) to $1,800. Cost of goods sold will decrease to 80 percent of sales. Accounts receivable, inventories, accounts payable, and accruals can all be expressed as a percentage of sales. The firm expects to increase its minimum cash balance to $50 at the beginning of Year 3. Current gross fixed assets are being depreciated on a straight-line basis over a 20 year period ($1,100/20) = $55 per year. The firm intends to add an additional $1,000 of gross fixed assets at the beginning of Year 3. These additional assets will be depreciated on a straightline basis over a 10-year period. The firm has already decided to increase notes payable by $90 at the start of Year 3, giving the firm a total of $350 of interest-bearing liabilities. The beforetax cost of this debt is expected to be 1 0 percent. The firm has already announced plans to repurchase $32 of its stock at the beginning of Year 3. The firm expects to pay out 50 percent of its net income to the shareholders in the form of dividends and to retain the remainder. Assume that the tax rate remains at 40 percent.


Page 9 of 57 Pages

3.

*

Do a first pass using the assumptions above and calculate the additional funds needed (AFN). A. B. C. D. E.

$982.00 $739.00 $896.00 $685.00 $802.00 Income Statement


Year 2

Year 3 First Pass

$1,200.00 -$1,020.00

$1,800.00 -$1,440.00

Depreciation

-$55.00

-$155.00

EBIT

$125.00

$205.00

Interest

-$25.00

-$35.00

EBT

$100.00

$170.00

Taxes (40%)

-$40.00

-$68.00

Net Income

$60.00

$102.00

Dividends

$40.00

$51.00

Assets

Year 2

Year 3 First Pass

Cash Accounts Receivable

$15.00 $200.00

$50.00 $300.00

Inventories

$250.00

$375.00

$465.00 $1,100.00

$725.00 $2,100.00

-$555.00

-$710.00

$545.00

$1,390.00

$1,010.00

$2,115.00


Liabilities & Equity Accounts Payable Notes Payable Accruals Current Liabilities

Year 2

Year 3 First Pass

$120.00 $50.00

$180.00 $140.00

$80.00

$120.00

$250.00

$440.00


Year 3 Second Pass

Year 3 Second Pass

Year 3 Second Pass

Page 10 of 57 Pages

Long-Term Debt Common Stock

$210.00 $382.00

$210.00 $350.00

Retained Earnings

$168.00

$219.00

Total

$1,010.00

$1,219.00

AFN

N/A

$896.00

4.

Now assume that the AFN determined above will be raised in the form of additional long-term debt. Also assume that the interest rate on this additional debt will be 10 percent. Finally, assume that the firm plans to maintain its dividend payout rate at 50 percent of net income, where the new level of net income will now account for the increase in interest expense. Do a second pass incorporating financial feedback effects and calculate the new level of additional funds needed (AFN).

*

A. B. C. D. E.

$26.88 $37.39 $32.76 $49.64 $43.13 Income Statement


Year 2

Year 3 First Pass

Year 3 Second Pass

$1,200.00 -$1,020.00

$1,800.00 -$1,440.00

$1,800.00 -$1,440.00

Depreciation EBIT

-$55.00 $125.00

-$155.00 $205.00

-$155.00 $205.00

Interest EBT

-$25.00 $100.00

-$35.00 $170.00

-$124.60 $80.40

Taxes (40%)

-$40.00

-$68.00

-$32.16

Net Income

$60.00

$102.00

$48.24

Dividends

$40.00

$51.00

$24.12

Assets

Year 2

Year 3 First Pass

Year 3 Second Pass


$15.00 $200.00

$50.00 $300.00

$50.00 $300.00

Inventories

$250.00

$375.00

$375.00

$465.00 $1,100.00

$725.00 $2,100.00

$725.00 $2,100.00

-$555.00

-$710.00

-$710.00

$545.00

$1,390.00

$1,390.00

$1,010.00

$2,115.00

$2,115.00



Page 11 of 57 Pages

Liabilities & Equity

Year 3 First Pass

Year 2

Accounts Payable Notes Payable

Year 3 Second Pass

$120.00 $50.00

$180.00 $140.00

$180.00 $140.00

$80.00

$120.00

$120.00


$250.00 $210.00 $382.00

$440.00 $210.00 $350.00

$440.00 $1,106.00 $350.00

Retained Earnings

$168.00

$219.00

$192.12

Total

$1,010.00

$1,219.00

$2,088.12

AFN

N/A

$896.00

$26.88

Accruals

Alternatively, Increase in Interest at 10% Interest Tax Shelter at 40% Decrease in Net Income Decline in Dividend (50%) Decline in Additions to Retained Earnings

5.

=

New AFN

Assume that you observe the following percentage returns (in decimal form) for the Market and for Security A. Use regression analysis to determine how the returns for Security A are related to the returns for the Market (that is, calculate its beta or slope coefficient). Based on these results, if the risk-free rate is expected to be 5 percent, and the expected return on the market is expected to be 8 percent, then what is the required rate of return for Firm A based on the capital asset pricing model (CAPM) using the equation for the security market line (SML)? Year 1 2 3 4 5

*

- $89.60 $35.84 - $53.76 +$26.88 - $26.88

A. B. C. D. E.

Market - .20 - .10 .10 .00 .25

Security A -.25 .00 .20 .35 .30

8.42% 8.85% 8.27% 8.59% 8.12%

Do the following on your HP-10BII .20

+/- Input

.25

+/- !+


Page 12 of 57 Pages

.10 .10 .00 .25 0 !

+/- Input Input Input Input !

y,m SWAP

.00 .20 .35 .30

!+ !+ !+ !+

0.108606557 (intercept) 1.139344262 (slope)

K = .05 + (.08 - .05)(1.139344262) = 8.42%

6.

You have been given the attached information for your company. The company expects sales to grow by 50 percent i n 2003 and operating costs should increase in proportion to sales. Fixed assets were being operated at 40 percent of capacity in 2002, but all other assets were used to full capacity. Underutilized fixed assets cannot be sold. Current assets and spontaneous liabilities should increase in proportion to sales during 2003. The company plans to finance any external funds needed as 35 percent notes payable and 65 percent common stock. Ignoring any financing feedback effects, what is the company’s ROE after adjusting for additional funds needed?

Sales Operating costs EBIT Interest EBT Taxes (40%) Net income

2002 $1,000.00 800.00 $ 200.00 16.00 $ 184.00 73.60 $ 110.40

Dividends (60%) Additions to R.E.

$ 66.24 $ 44.16

Current assets Net fixed assets Total assets

$ 700.00 300.00 $1,000.00

A/P and accrued liabilities N/P Common stock Retained earnings Total liabilities & equity

$ 150.00 200.00 150.00 500.00 $1,000.00

2003 Forecast

2003 After AFN

AFN Profit margin ROE Debt/Assets

11.04% 16.98 35.00


Page 13 of 57 Pages

*

Current ratio Payout ratio

2.00_ 60.00%

AFN Financing: N/P Common stock

Weights 0.3500 0.6500 1.0000

A. B. C. D. E.

Dollars

19.99% 17.67% 21.73% 25.68% 23.24%

Sales Operating costs EBIT Interest EBT Taxes (40%) Net income

2002 $1,000.00 800.00 $ 200.00 16.00 $ 184.00 73.60 $ 110.40

2003 Forecast 2003 After AFN $1,500.00 $1,500.00 1,200.00 1,200.00 $ 300.00 $ 300.00 16.00 16.00 $ 284.00 $ 284.00 113.60 113.60 $ 170.40 $ 170.40

Dividends (60%) Additions to R.E.

$ 66.24 $ 44.16

$ 102.24 $ 68.16

$ 102.24 $ 68.16

Current assets Net fixed assets* Total assets

$ 700.00 300.00 $1,000.00

$1,050.00 300.00 $1,350.00

$1,050.00 300.00 $1,350.00

A/P and accrued liabilities N/P Common stock Retained earnings Total liabilities & equity

$ 150.00 200.00 150.00 500.00 $1,000.00

$ 225.00 200.00 150.00 568.16 $1,143.16

$ 225.00 272.39 284.45 568.16 $1,350.00

AFN

$ 206.84

Profit margin ROE Debt/Assets Current ratio Payout ratio

11.04% 16.98 35.00 2.00x 60.00%

11.36% 23.73 31.48 2.47x 60.00%

AFN Financing: N/P Common stock

Weights 0.3500 0.6500 1.0000

Dollars 72.39 134.45 206.84


11.36% 19.99 36.84 2.11x 60.00%

Page 14 of 57 Pages

ROE = NI / Equity = $170.40 / ($284.45 + $568.16) = $170.40 / $852.61 ROE = 19.99%

7.

A well-managed company has reported the following sales and inventories over the past three years: Year 2000 2001 2002

Sales $1,650,000 1,800,000 2,250,000

Inventories $150,000 165,000 185,000

The company forecasts that its sales will be $2,800,000 in 2003, and the company uses regression analysis (on the basis of the last three years' data) to forecast its inventories. What are its forecasted inventories for 2003?

*

A. B. C. D. E.

$209,000.35 $225,689.95 $216,282.05 $231,000.25 $237,667.85

1,650,000 INPUT 1,800,000 INPUT 2,250,000 INPUT

150,000 !+ 165,000 !+ 185,000 !+

0 " y,m = intercept = $61,923.08 "

Swap = slope = 0.055128205

To predict at a level of sales of $2,800,000: 2,800,000 " y,m = prediction = $216,282.05 Alternatively, $216,282.05 = $61,923.08 + ($2,800,000)(0.055128205)

8.

Your company’s balance sheet for 2002 is given below:

Cash Accounts receivable Inventories Net fixed assets

2002 Balance Sheet $ 10 Accounts payable 25 Notes payable 40 Accrued wages and taxes 75 Long-term debt Common equity Total liabilities


$ 15 20 15 30 70

Page 15 of 57 Pages

Total assets

$150

and equity

$150

Sales during 2002 were $200, and they are expected to rise by 50 percent to $300 during the coming year (2003). Also, during the last year fixed assets were being utilized to only 85 percent of capacity, so your company could have supp orted $200 of sales with fixed assets that were only 85 percent of last year's actual fixed assets. Assume that your company’s profit margin will remain constant at 5 percent, that the company will continue to pay out 60 percent of its earnings as dividends, and that all current assets and spontaneous liabilities will increase proportionately with sales. Do a first pass (do not consider financing feedback effects) and determine what additional funds will be needed (AFN) during the next year.

*

A. B. C. D. E.

$53.38 $49.76 $37.13 $40.29 $44.85

Current Sales = $200 New Sales = ($200)(1.5) = $300 Fixed Assets currently used = ($75)(.85) = $63.75 Fixed Assets / Sales = $63.75 / $200 = 31.875% New level of Fixed Assets needed = ($300)(.31875) = $95.63 Addition to retained earnings = ($300)(0.05)(1-.60) = $6.00 Balance sheet solution:

Cash Accounts receivable Inventories Net fixed assets

Total assets

Projected 2003 Balance Sheet $ 15.00 Accounts payable 37.50 Notes payable 60.00 Accrued wages and taxes 95.63 Long-term debt Common equity Total liabilities $208.13 and equity

$ 22.50 20.00 22.50 30.00 76.00 $171.00

AFN = $208.13 - $171.00 = $37.13

9.

Over the past four years, your well-managed company has had the following link between its inventories and its sales: Year 1999 2000

Sales $200 million 250 million

Inventories $35 million 38 million


Page 16 of 57 Pages

2001 2002

400 million 500 million

55 million 70 million

Your company is in the process of generating its forecasted financial statements for 2003. The company first generates a forecast for sales and then, given its sales forecast, uses a regression model (using data given above) to forecast its inventories for 2003. Assuming that the forecasted sales for 2003 are $700 million, determine what the forecasted inventories will be for 2003. *

A. B. C. D. E.

$92.04 $89.64 $86.93 $95.20 $98.59

million million million million million

Determine the regression equation using your calculator: 200 INPUT 35 !+ 250 INPUT 38 !+ 400 INPUT 55 !+ 500 INPUT 70 !+ 0 "y ,m displays the y-intercept, $9.890110 wap displays the slope of the line, 0.117363 "S Inventories = $9.89011 + (0.117363)(700 million) = $92.04 million Alternatively, Use your calculator to predict inventories directly: 700 "y ,m displays the predicted level of inventories, $92.04

10.

You are given the actual income statement and balance sheet below for year-end 2002. Now make the following assumptions: 1. 2. 3. 4. 5. 6. 7. 8.

Sales are expected to increase from $4,000 to $4,400 in 2003 (10% increase). Cost of goods sold is expected to decrease to 88 percent in 2003. Current assets and spontaneously increasing liabilities can be expressed as a percentage of sales. Fixed plant and equipment is being used at 80 percent of capacity. If fixed assets are increased, they must be increased in blocks of $500. The firm expects to pay a dividend of $200 in 2003. The firm expects to increase its debt to $750 at the beginning of 2003, resulting in interest expense of $75 for 2003. The firm expects to sell additional shares of common stock worth $100. The firm expects to make any adjustments for additional funds needed (AFN) through adjustments (increases or decreases) to the am ount added through retained earnings, or alternatively (decreases or increases) to the amount paid out in dividends.


Page 17 of 57 Pages

Income Statement

2002 Actual


$4,000.00 $3,600.00

EBIT Interest (10%)

$400.00 $50.00

EBT Taxes (40%)

$350.00 $140.00

Net Income

$210.00

Dividends

$150.00

Addition to RE

$60.00

Balance Sheet

2002 Actual

Current Assets Net Fixed Assets

$5,000.00 $3,000.00

Total Assets

$8,000.00

A/P and Accruals

$1,500.00

Debt

$500.00


$1,000.00 $5,000.00


$8,000.00

2003 Forecast

2003 After AFN

2003 Forecast

2003 After AFN

Additional Funds Needed Using the tables above (if you wish) do a first pass and determine the additional funds needed, then do a second pass and make any adjustments necessary to dividends and additions to retained earnings so that your balance sheet balances. How much will the firm then pay out in dividends?

*

A. B. C. D. E.

$165.80 $198.80 $233.80 $271.80 $302.80

Income Statement

2002 Actual

2003 Forecast


2003 After AFN

Page 18 of 57 Pages


$4,000.00 $3,600.00

$4,400.00 $3,872.00

$4,400.00 $3,872.00

EBIT Interest (10%)

$400.00 $50.00

$528.00 $75.00

$528.00 $75.00

EBT Taxes (40%)

$350.00 $140.00

$453.00 $181.20

$453.00 $181.20

Net Income

$210.00

$271.80

$271.80

Dividends

$150.00

$200.00

$271.80

Addition to RE

$60.00

$71.80

$0.00

Balance Sheet

2002 Actual

2003 Forecast

2003 After AFN

Current Assets Net Fixed Assets

$5,000.00 $3,000.00

$5,500.00 $3,000.00

$5,500.00 $3,000.00

Total Assets

$8,000.00

$8,500.00

$8,500.00

A/P and Accruals

$1,500.00

$1,650.00

$1,650.00

Debt

$500.00

$750.00

$750.00


$1,000.00 $5,000.00

$1,100.00 $5,071.80

$1,100.00 $5,000.00


$8,000.00

$8,571.80

$8,500.00


11.

-$71.80

You are given the following historical data for sales and inventory: Year 2002 2001 2000 1999 1998 1997

Sales $2,750.00 $2,600.00 $2,400.00 $1,950.00 $2,500.00 $2,000.00

Inventory ? $725.00 $700.00 $650.00 $600.00 $500.00

Perform a regression analysis (the relationship is not strictly linear, so you will not be able to use rise/run to determine the slope) and determine what inventory will be in 2002, rounded off to the nearest whole dollar. A.

$692


Page 19 of 57 Pages

*

B. C. D. E.

$716 $754 $781 $807

Using your calculator, you can use the following steps to perform your r egression: 2000 Input 2500 Input 1950 Input 2400 Input 2600 Input

500 !+ 600 !+ 650 !+ 700 !+ 725 !+

Solve for Intercept = $233.27 Solve for Slope = .1754 Solve for Sales of $2,750 => $716 of Inventory

12.

Your company had the following balance sheet for 2004:

Assets

2004

Cash Accounts Receivable Inventories Net Fixed Assets

$1,600 $900 $1,900 $68,000

Total Assets

$72,400


2004

Accounts Payable Accrued Wages Notes Payable Long-Term Debt Common Stock Retained Earnings Total Liabilities & Equity

$700 $300 $4,000 $53,000 $6,400 $8,000 $72,400

Assume that you expect sales in 2005 to increase from $20,000 to $40,000, increasing net income to $2,000, all of which will be added to retained earnings. Also assume that you feel that you can handle the increase in sales without adding any fixed assets, but that all other current assets and spontaneous liabilities will increase in proportion to sales. Using a spreadsheet approach, but ignoring financing feedback effects, determine the additional capital that you will need to raise. *

A. B. C. D. E.

$2,075 $1,400 $1,625 $2,300 $1,850

Assets

2005


2005

Cash Accounts Receivable Inventories

$3,200 $1,800 $3,800

Accounts Payable Accrued Wages Notes Payable

$1,400 $600 $4,000


Page 20 of 57 Pages

Net Fixed Assets

$68,000

Long-Term Debt Common Stock Retained Earnings

$53,000 $6,400 $10,000

Total Assets

$76,800

Total Liabilities & Equity

$75,400

Additional funding needs = $76,800 - $75,400 = $1,400

13.


Assets

2004


2004

Current Assets Fixed Assets

$1,200,000 $800,000

Accounts Payable Accrued Wages Notes Payable Long-Term Debt Total Common Equity

Total Assets

$2,000,000


$200,000 $200,000 $200,000 $600,000 $800,000 $2,000,000

Assume that in 2004, the company reported sales of $10 million, net income of $200,000, and dividends of $120,000. Now assume that (1) the company anticipates its sales will increase 20 percent in 2005, (2) its dividend payout will remain at 60 percent, and (3) the company is at full capacity, and that all of its assets and spontaneous liabilities will increase proportionately with an increase in sales. Finally, assume the company uses the AFN formula and all additional funds needed (AFN) will come from issuing new long-term debt. Given its forecast, and ignoring financing feedback effects, determine how much long-term debt the company will need to issue in 2005. *

A. B. C. D. E.

$224,000 $200,000 $216,000 $192,000 $208,000

A*/S0 = $2,000,000 / $10,000,000 = 20% L*/S0 = ($200,000 + $200,000) / $10,000,000 = 4% PM = $200,000 / $10,000,000 = 2% (1 - DPR) = 1 - .60 = 40% S1 = ($10,000,000) (1.20) = $12,000,000 !S

= $12,000,000 - $10,000,000 = $2,000,000

AFN = (.2)($2,000,000) - (.04)($2,000,000) - ($12,000,000)(.02)(.4)


Page 21 of 57 Pages

AFN = $400,000 - $80,000 - $96,000 = $224,000 14.

You are given below the 2004 year-end financial statements for your firm (in thousands) and have been asked to project the firm’s funding needs for 2005. You may make the following assumptions when making your forecast: 1. 2. 3. 4. 5. 6. 7. 8. 9. 10.

Sales are expected to increase by 30 percent over the coming year -- they will increase to $19,500,000. Operating costs are expected to decrease to 77 percent of sales. The interest rate on long-term debt will remain at 10 percent for 2005, but the interest rate on short-term debt, such as notes payable, will go up to 12 percent. Taxes are expected to increase to 40 percent in 2005. The firm expects to increase its dividend per share to $1.80 in 2005. All current assets will increase proportionately with sales. At the end of 2004, fixed assets (property plant and equipment) are being operated at only 80 percent of capacity. Fixed assets are lumpy. If the firm must increase its fixed assets, it will do so by adding an amount equal to $1,500,000. Accounts payable and accruals will increase proportionately with sales. Notes payable will increase to $1,500,000 at the start of 2005.

Given this information, do a “first pass” and determine the firm’s additional funds needed (AFN) for 2005.

Income Statement (In Thousands) Sales Operating costs Earnings before interest and taxes Interest Earnings before taxes Taxes Net income available to common stockholders Common dividends Balance Sheet (In Thousands) Assets: Cash and marketable securities Accounts receivable Inventories Total current assets Property plant and equipment Total assets

Year: 2004

First Pass

$15,000.00 $12,000.00 $3,000.00 $250.00 $2,750.00 $962.50 $1,787.50 $1,500.00 Year: 2004

First Pass

$1,500.00 $4,500.00 $6,000.00 $12,000.00 $7,500.00 $19,500.00

Liabilities and equity:


Page 22 of 57 Pages

Accounts payable Notes payable Accruals Total current liabilities Long-term bonds Total liabilities Common stock (1 million shares) Retained earnings Total common equity Total liabilities and equity

$3,500.00 $1,000.00 $2,500.00 $7,000.00 $1,500.00 $8,500.00 $10,000.00 $1,000.00 $11,000.00 $19,500.00


*

A. B. C. D. E.

$1,734.40 $2,276.00 $1,943.60 $2,107.00 $2,423.00

Income Statement (In Thousands) Sales Operating costs Earnings before interest and taxes Interest Earnings before taxes Taxes Net income available to common stockholders Common dividends Balance Sheet (In Thousands) Assets: Cash and marketable securities Accounts receivable Inventories Total current assets Property plant and equipment Total assets Liabilities and equity: Accounts payable


Year: 2004 $15,000.00 $12,000.00 $3,000.00 $250.00 $2,750.00 $962.50 $1,787.50 $1,500.00 Year: 2004

First Pass $19,500.00 $15,015.00 $4,485.00 $330.00 $4,155.00 $1,662.00 $2,493.00 $1,800.00 First Pass

$1,500.00 $4,500.00 $6,000.00 $12,000.00 $7,500.00 $19,500.00

$1,950.00 $5,850.00 $7,800.00 $15,600.00 $9,000.00 $24,600.00

$3,500.00

$4,550.00

Page 23 of 57 Pages

Notes payable Accruals Total current liabilities Long-term bonds Total liabilities Common stock (1 million shares) Retained earnings Total common equity Total liabilities and equity

$1,000.00 $2,500.00 $7,000.00 $1,500.00 $8,500.00 $10,000.00 $1,000.00 $11,000.00 $19,500.00


15.

$1,500.00 $3,250.00 $9,300.00 $1,500.00 $10,800.00 $10,000.00 $1,693.00 $11,693.00 $22,493.00 $2,107.00

Assume that you are at your firm’s fiscal year end and that you have been given the following information about the firm: Sales this year = $2,000 Sales next year = $2,500 Sales increase projected for the coming year = 25 percent = $500 Net income this year = $250 Dividend payout rate (all years) = 50 percent Current accounts payable = $500 Current accrued wages and taxes = $200 Also assume that, except for the accounts noted, there were no other current liabilities, that all assets and spontaneous liabilities can be expressed as a percent of sales, that the firm’s profit margin, dividend payout rate, etc., will remain constant over the coming year, and that the firm has calculated that its additional funds needed over the coming year will be $100. Given this information, and using the equation method, determine the firm’s current level of total assets. (Hint: You are looking for A* in the equation. Profit Margin is a function of Net Income.)

*

A. B. C. D. E.

$1,750.00 $1,725.00 $1,825.00 $1,775.00 $1,800.00

AFN = (A*/S0)(!S) - (L*/S0)(!S) - (PM)(S1)(1-DPR) S0 = $2,000 S1 = ($2,000)(1.25) = $2,500 !S = $2,500 - $2,000 = $500 L* = $500 + $200 = $700 PM = $250 / $2,000 = 12.5% $100 = (A* / $2,000)($500) - ($700 / $2,000)($500) - (.125)($2,500)(1 - .50) $100 = (A* )(.25) - $175.00 - $156.25


Page 24 of 57 Pages

A* = ($100 + $175.00 + $156.25) / (.25) = ($431.25) / (.25) = $1,725.00 16.

Assume that you have done a “first pass” and have determined that your firm’s additional funds needed for the coming year will $10,000. You have decided to meet this need by issuing $6,000 of additional equity and $4,000 of long-term debt. You assume that dividend payments will increase by $500 because of the additional shares sold, and that the before-tax interest rate on the new debt will be 12 percent. Given this information, and assuming that the firm’s tax rate is 40 percent, determine what the firm’s additional funds needed will be if you now do a second pass and include these financing decisions. A. B. C. D. E.

*

$740.00 $764.00 $788.00 $752.00 $776.00

Second Pass AFN = After-tax Financing Charges AFN = $500 + ($4,000)(.12)(1 - .40) = $788.00 17

.

Assume that your company would like to determine the growth rate in sales that will allow it to expand as much as possible without having to issue external capital (that is, its AFN will be equal to 0). Also assume that you have gathered the data listed below for the firm. Given this information, and using the AFN formula, determine the maximum growth rate of sales that the firm can sustain without having to issue external capital. • • • • •

*

A. B. C. D. E. !S

Capital Intensity Ratio = 1.40 Profit Margin = 8% Dividend Payout Ratio = 25% Current Sales = $200,000 Spontaneous Liabilities = $20,000 5.27% 4.84% 5.63% 4.41% 6.02% = S1 - S 0 = (S 0) (g)

S1 = (S 0) (1+g) Where g = growth rate AFN = 0 = (1.40)(S0)(g) - ($20,000 / $200,000) (S0)(g) - (S0)(1+g)(.08)(1-.25) AFN = 0 = (1.40)(S0)(g) - (.10) (S0)(g) - (S0)(1)(.08)(1-.25) - (S0)(g)(.08)(1-.25) AFN = 0 = (1.40)(S0)(g) - (.10) (S0)(g) - (S0)(.06) - (S0)(g)(.06) (S0)(.06) = (1.40g)(S0) - (.10g)(S0) - (.06g)(S0) = (1.24g)(S0)


Page 25 of 57 Pages

# .06 #

= (1.24)(g)

g = .06 / 1.24 = 4.8387097% = 4.84%

Proof: S1 = ($200,000)(1.048387097) = $209,677.42 !S

= $9,677.42

AFN = (1.40)($9,677.42) - (.10)($9,677.40) - ($209,677.40)(.08)(1-.25) AFN = $13,548.39 - $967.74 - $12,580.65 = $0.00

18.

You are given the following income statement and balance sheet: Income Statement Sales

$15,000

EBT Taxes (40%)

$800 $320

Net Income

$480

Balance Sheet Cash A/R Inventories

$100 $2,000 $4,000

Accounts Payable Debt Common Stock

$1,000 $4,000 $2,000

Total CA Fixed Assets

$6,100 $1,900

Retained Earnings

$1,000

Total Assets

$8,000

Total Claims

$8,000

Now make the following assumptions: • • • •

Sales are expected to increase by $5,000 over the coming year. All assets and accounts payable can be expressed as a percentage of sales. The firm’s profit margin will remain at 3.2 percent. The firm has a dividend payout rate of 75 percent.

Using the equation method, determine the additional funds needed for the coming year. A. B. C.

$2,136.24 $2,012.43 $2,099.51


Page 26 of 57 Pages

*

D. E.

$2,173.33 $2,045.86

AFN = ($8,000 / $15,000)($5,000) - ( $1,000 / $15,000)($5,000) - ($20,000)(.032)(1-.75) AFN = $2,666.66 - $333.33 - $160.00 = $2,173.33

YOU ARE GIVEN THE FOLLOWING INFORMA TION FOR QUESTIONS 19 - 20: Income Statement (In Millions)

2004

Sales (all on credit; 360-day year) Operating costs EBITDA Depreciation and amortization Earnings before interest and taxes Interest (10%) Earnings before taxes Taxes (40%) Net income Common dividends

4,500.00 -3,825.00 675.00 -120.00 555.00 -123.34 431.66 -172.66 259.00 225.00

Balance Sheet (In Millions)

2004

Assets: Cash Accounts receivable Inventories Total current assets Net plant and equipment Total assets

450.00 375.00 675.00 1,500.00 1,080.00 2,580.00

Liabilities and equity: Accounts payable Notes payable Accruals Total current liabilities Long-term bonds Total debt Common stock (50 million shares) Retained earnings Total common equity Total liabilities and equity

562.50 783.40 225.00 1,570.90 450.00 2,020.90 400.00 159.10 559.10 2,580.00

2005 w/o

2005 w/

2005 w/o

2005 w/

AFN


Page 27 of 57 Pages

19.

Now make the following assumptions: •

• •

• • •

Operating costs, current assets, accounts payable, and accruals will all increase proportionately with sales. Sales are expected to increase to $5,000 in 2005 The firm expects to add $200 to fixed assets. This increase will be depreciated on a straight-line basis over 10 years. All other fixed assets will continue to be depreciated at $120 per year. The firm expects to pay off all of its notes payable at the beginning of 2005. Long-term debt will continue to have an interest rate of 10 percent. The firm plans to increase its total dividend to $250 in 2005.

Now, without considering how it is to be fu nded, do a first pass and determine the additional funds needed.

*

A. B. C. D. E.

$794.28 $872.33 $833.57 $955.91 $904.45


Page 28 of 57 Pages

Income Statement (In Millions)

2004


4,500.00 -3,825.00 675.00 -120.00 555.00 -123.34 431.66 -172.66 259.00 225.00


2004

2005 w/o 5,000.00 -4,250.00 750.00 -140.00 610.00 -45.00 565.00 -226.00 339.00 250.00 2005 w/o


450.00 375.00 675.00 1,500.00 1,080.00 2,580.00

500.00 416.67 750.00 1,666.67 1,140.00 2,806.67


562.50 783.40 225.00 1,570.90 450.00 2,020.90 400.00 159.10 559.10 2,580.00

625.00 0.00 250.00 875.00 450.00 1,325.00 400.00 248.10 648.10 1,973.10

AFN

2005 w/

2005 w/

833.57

20.

Now assume that the firm plans to raise all of its additional funds needed as equity, but that it will maintain dividends at $250. Do a second pass and determine the new level of additional funds needed.

*

A. B. C. D. E.

$ 0.00 $100.00 $ 25.00 $ 75.00 $ 50.00


Page 29 of 57 Pages

Income Statement (In Millions)

2004


4,500.00 -3,825.00 675.00 -120.00 555.00 -123.34 431.66 -172.66 259.00 225.00


2004

2005 w/o 5,000.00 -4,250.00 750.00 -140.00 610.00 -45.00 565.00 -226.00 339.00 250.00 2005 w/o

2005 w/ 5,000.00 -4,250.00 750.00 -140.00 610.00 -45.00 565.00 -226.00 339.00 250.00 2005 w/


450.00 375.00 675.00 1,500.00 1,080.00 2,580.00

500.00 416.67 750.00 1,666.67 1,140.00 2,806.67

500.00 416.67 750.00 1,666.67 1,140.00 2,806.67


562.50 783.40 225.00 1,570.90 450.00 2,020.90 400.00 159.10 559.10 2,580.00

625.00 0.00 250.00 875.00 450.00 1,325.00 400.00 248.10 648.10 1,973.10

625.00 0.00 250.00 875.00 450.00 1,325.00 1,233.57 248.10 1,481.67 2,806.67

833.57

0.00

AFN

No calculations are actually needed, since the only things that will cause AFN to be different from zero on the second pass are financing feedback effects. Since the dividend is maintained at $250, there are no feedback effects and the AFN will be $0.00

21.

You are given below the 2005 year-end financial statements for your firm (in thousands) and have been asked to project the firm’s funding needs for 2006. You may make the following assumptions when making your forecast:


Page 30 of 57 Pages

1. 2. 3. 4. 5. 6. 7. 8. 9. 10.

Sales are expected to increase by 20 percent over the coming year -- they will increase to $12,000,000. Operating costs are expected to decrease to 75 percent of sales. The interest rate on all debt will remain at 10 percent for 2006. Taxes are expected to remain at 40 percent in 2006. The firm expects to increase its dividend per share to $0.60 in 2006. All current assets will increase proportionately with sales. At the end of 2005, fixed assets (property plant and equipment) are being operated at only 80 percent of capacity (you may ignore depreciation). Fixed assets are lumpy. If the firm must increase its fixed assets, it will do so by adding an amount equal to $2,500,000 (you may ignore depreciation). Accounts payable and accruals will increase proportionately with sales. Notes payable will decrease to $500,000 at the start of 2006.

Given this information, do a “first pass” and determine the firm’s additional funds needed (AFN) for 2006. Income Statement (In Thousands)

Year: 2005

Sales

$10,000.00

Operating costs

$ 8,000.00

Earnings before interest and taxes Interest Earnings before taxes

$ 2,000.00 $

250.00

$ 1,750.00

Taxes

$

Net income available to common stockholders

$ 1,050.00

Common dividends

$

Balance Sheet (In Thousands)

First Pass

700.00 550.00

Year: 2005

First Pass

Assets: Cash and marketable securities

$ 1,500.00

Accounts receivable

$ 4,500.00

Inventories

$ 6,000.00

Total current assets Property plant and equipment

$12,000.00 $ 7,500.00

Total assets

$19,500.00

Liabilities and equity: Accounts payable

$ 3,500.00

Notes payable

$ 1,000.00

Accruals

$ 2,500.00

Total current liabilities

$ 7,000.00

Long-term bonds

$ 1,500.00

Total liabilities

$ 8,500.00


Page 31 of 57 Pages

Common stock (1 million shares)

$10,000.00

Retained earnings

$ 1,000.00

Total common equity

$11,000.00

Total liabilities and equity

$19,500.00


*

A. B. C. D. E.

$690 $585 $655 $725 $620

Income Statement (In Thousands)

Year: 2005

First Pass

Sales

$10,000.00

$12,000.00

Operating costs

$ 8,000.00

$ 9,000.00

$ 2,000.00

$ 3,000.00

$

$

Earnings before interest and taxes Interest Earnings before taxes

250.00

200.00

$ 1,750.00

$ 2,800.00

Taxes

$

700.00

$ 1,120.00

Net income available to common stockholders

$ 1,050.00

$ 1,680.00

Common dividends

$

$

Balance Sheet (In Thousands)

550.00

Year: 2005

600.00

First Pass

Assets: Cash and marketable securities

$ 1,500.00

$ 1,800.00

Accounts receivable Inventories

$ 4,500.00 $ 6,000.00

$ 5,400.00 $ 7,200.00

$12,000.00

$14,400.00

Property plant and equipment

$ 7,500.00

$ 7,500.00

Total assets

$19,500.00

$21,900.00

Accounts payable

$ 3,500.00

$ 4,200.00

Notes payable Accruals

$ 1,000.00 $ 2,500.00

$ 500.00 $ 3,000.00

$ 7,000.00

$ 7,700.00

Long-term bonds

$ 1,500.00

$1,500.00

Total liabilities

$ 8,500.00

$9,200.00

Common stock (1 million shares)

$10,000.00

$10,000.00

Retained earnings

$ 1,000.00

$2,080.00

Total current assets

Liabilities and equity:

Total current liabilities


Page 32 of 57 Pages

Total common equity

$11,000.00

$12,080.00

Total liabilities and equity

$19,500.00

$21,280.00


22.

$620.00

Assume that you wish to use the spreadsheet method to forecast additional funds needed and have made the following assumptions: • •

•

• • •

•

•

•

Sales will increase by 30 percent. Operating costs will decrease from 60 percent of sales down to 58 percent of sales. Accounts receivable, inventories, accounts payable, and accruals can all be expressed as a percent of sales. Cash will be decreased to $400 for the coming year. The firm is currently operating its fixed assets at 75 percent of capacity. If the firm is required to add new fixed assets, it will add $2,000 to gross plant and equipment (fixed assets) at the beginning of Year 1. Current fixed assets are being depreciated on a straight line basis and have been in use for 4 years. Any new fixed assets will be depreciated on the same straight line basis. The firm must pay off its notes payable at the beginning of Year 1, and plans to decrease its long-term debt to $500. The interest rate on both of these are (and will continue to be) 10 percent. The firm has already announced that its total dividend to be paid out will be increased to $600 in Year 1.

Given this information, do a first pass and determine the amount of additional funds needed for Year 1. Income Statement

Year 0

Sales Operating Costs Depreciation

$5,000.00 -$3,000.00 -$ 600.00

EBIT Interest

$1,400.00 -$ 185.00

EBT Taxes (40%)

$1,215.00 -$ 486.00

Net Income

$ 729.00

Dividends Paid Out

$ 291.60

Assets

Year 0


$ 500.00 $1,500.00

Inventories

$2,000.00


Year 1 (1st)

Year 1 (1st)

Page 33 of 57 Pages

Current Assets Gross Plant & Equipment Less: Depreciation Net Plant & Equipment Total Assets

$4,000.00 $6,000.00 -$2,400.00 $3,600.00 $7,600.00


Year 0

Accounts Payable Notes Payable Accruals

$1,250.00 $ 850.00 $ 500.00

Current Liabilities

$2,600.00

Long-Term Debt Common Stock

$1,000.00 $3,500.00

Retained Earnings

$ 500.00


Year 1 (1st)

$7,600.00


*

A. B. C. D. E.

$515.00 $524.00 $518.00 $527.00 $521.00 Year 1 (1st)

Income Statement

Year 0

Sales

$5,000.00

$6,500.00

Operating Costs Depreciation

-$3,000.00 -$ 600.00

-$3,770.00 -$ 600.00

EBIT Interest

$1,400.00 -$ 185.00

$2,130.00 -$ 50.00

EBT

$1,215.00

$2,080.00

Taxes (40%)

-$ 486.00

-$ 832.00

Net Income

$ 729.00

$1,248.00

Dividends Paid Out

$ 291.60

$ 600.00 Year 1 (1st)

Assets

Year 0

Cash

$ 500.00

$ 400.00

Accounts Receivable Inventories

$1,500.00 $2,000.00

$1,950.00 $2,600.00

$4,000.00

$4,950.00

$6,000.00

$6,000.00

Current Assets Gross Plant & Equipment


Page 34 of 57 Pages

Less: Depreciation Net Plant & Equipment Total Assets

-$2,400.00

-$3,000.00

$3,600.00

$3,000.00

$7,600.00

$7,950.00 Year 1 (1st)


Year 0


$1,250.00 $ 850.00

$1,625.00 $ 0.00

Accruals

$ 500.00

$ 650.00


$2,600.00 $1,000.00 $3,500.00

$2,275.00 $ 500.00 $3,500.00

Retained Earnings

$ 500.00

$1,148.00

$7,600.00

$7,423.00

Total Liabilities & Equity Additional Funds Needed

$ 527.00

YOU ARE GIVEN THE FOLLOWING INFORMA TION FOR PROBLEMS 23 - 24: Income Statement

Year 0


$5,000.00 -$3,000.00

Depreciation EBIT Interest EBT Taxes (40%)

$1,215.00 -$486.00 $291.60

Year 0 $500.00

Accounts Receivable Inventories

$1,500.00 $2,000.00

Current Assets Gross Plant & Equipment Less: Depreciation

$4,000.00 $6,000.00 -$2,400.00

Total Assets

Year 1 (2nd)

-$185.00

Dividends Paid Out

Net Plant & Equipment

Year 1 (1st)

$1,400.00

$729.00

Cash

Year 1 (2nd)

-$600.00

Net Income

Assets

Year 1 (1st)

$3,600.00 $7,600.00


Page 35 of 57 Pages


Year 0

Accounts Payable

$1,250.00

Notes Payable Accruals Current Liabilities Long-Term Debt Common Stock Retained Earnings Total Liabilities & Equity

Year 1 (1st)

Year 1 (2nd)

$850.00 $500.00 $2,600.00 $1,000.00 $3,500.00 $500.00 $7,600.00

Additional Funds Needed 23.


•

• • •

•

•

•

Sales will increase by 20 percent. Operating costs will increase from 60 percent of sales up to 65 percent of sales. Accounts receivable, inventories, accounts payable, and accruals can all be expressed as a percent of sales. Cash will be increased to $1,000 for the coming year. The firm is currently operating its fixed assets at 90 percent of capacity. If the firm is required to add new fixed assets, it will add $1,000 to gross plant and equipment (fixed assets) at the beginning of Year 1. Current fixed assets are being depreciated on a straight line basis and have been in use for 4 years. Any new fixed assets will be depreciated on the same straight line basis. The firm has already made arrangements to increase its notes payable to $1,000 at the beginning of Year 1, while maintaining its long-term debt at $1,000. The interest rate on both of these will be 10 percent. The firm has already announced that its total dividend to be paid out will be increased to $350 in Year 1.

Given this information, do a first pass and determine the amount of additional funds needed for Year 1.

*

A. B. C. D. E.

$670.00 $650.00 $630.00 $660.00 $640.00 Year 1 (1st)

Income Statement

Year 0

Sales

$5,000.00

$6,000.00

-$3,000.00 -$600.00

-$3,900.00 -$700.00

Operating Costs Depreciation


Year 1 (2nd)

Page 36 of 57 Pages

EBIT Interest

$1,400.00 -$185.00

$1,400.00 -$200.00

EBT

$1,215.00

$1,200.00

Taxes (40%)

-$486.00

-$480.00

Net Income

$729.00

$720.00

Dividends Paid Out

$291.60

$350.00

Year 0


$500.00 $1,500.00 $2,000.00

$1,000.00 $1,800.00 $2,400.00

$4,000.00 $6,000.00 -$2,400.00

$5,200.00 $7,000.00 -$3,100.00

$3,600.00

$3,900.00

$7,600.00

$9,100.00


Year 0


$1,250.00 $850.00

$1,500.00 $1,000.00

$500.00

$600.00

$2,600.00

$3,100.00

$1,000.00 $3,500.00 $500.00

$1,000.00 $3,500.00 $870.00

$7,600.00

$8,470.00

Current Liabilities Long-Term Debt Common Stock Retained Earnings Total Liabilities & Equity Additional Funds Needed

*

Year 1 (1st)


Accruals

24.

Year 1 (1st)

Assets

Year 1 (2nd)

Year 1 (2nd)

$630.00

Assume that you intend to raise the additional funds needed (calculated above) by issuing both long-term debt and new common stock (in the ratio of 50% debt and 50% stock), and that this will cause your forecasted interest to increase to $224.40 (instead of $200.00), and forecasted dividends to increase to $375.25 (instead of $350.00). Given this information, determine the level of additional funds needed that will arise from a second pass. A. B. C. D. E.

$34.94 $42.43 $49.65 $28.16 $39.89


Page 37 of 57 Pages

The second pass AFN is due entirely to financing feedback effects. Interest has gone up by $24.40, which will produce an offsetting tax shelter of $9.76, giving a net cost of debt of $14.64, and dividends has increased by $25.25. This gives total financing feedback of: $14.64 + $25.25 = $39.89 A full forecast is, therefore, not required (you do not have to get #26 correct in order to do #27), but one is given below to show that the above answer is correct. Year 1 (1st)

Year 1 (2nd)

Income Statement

Year 0


$5,000.00 -$3,000.00

$6,000.00 -$3,900.00

$6,000.00 -$3,900.00

-$600.00

-$700.00

-$700.00

EBIT Interest

$1,400.00 -$185.00

$1,400.00 -$200.00

$1,400.00 -$224.40

EBT Taxes (40%)

$1,215.00 -$486.00

$1,200.00 -$480.00

$1,175.60 -$470.24

Net Income

$729.00

$720.00

$705.36

Dividends Paid Out

$291.60

$350.00

$375.25

Depreciation

Year 1 (1st)

Year 1 (2nd)

Assets

Year 0


$500.00 $1,500.00 $2,000.00

$1,000.00 $1,800.00 $2,400.00

$1,000.00 $1,800.00 $2,400.00

$4,000.00 $6,000.00 -$2,400.00

$5,200.00 $7,000.00 -$3,100.00

$5,200.00 $7,000.00 -$3,100.00

$3,600.00

$3,900.00

$3,900.00

$7,600.00

$9,100.00

$9,100.00


Year 1 (1st)

Year 1 (2nd)


Year 0

Accounts Payable

$1,250.00

$1,500.00

$1,500.00

$850.00 $500.00

$1,000.00 $600.00

$1,000.00 $600.00

$2,600.00

$3,100.00

$3,100.00

$1,000.00 $3,500.00 $500.00

$1,000.00 $3,500.00 $870.00

$1,315.00 $3,815.00 $830.11

$7,600.00

$8,470.00

$9,060.11

Notes Payable Accruals Current Liabilities Long-Term Debt Common Stock Retained Earnings Total Liabilities & Equity


Page 38 of 57 Pages


25.

$630.00

$39.89

Assume that you are given the following historical relationship between a firm’s sales and its level of inventory. Year

Sales

Inventory

1 2 3 4 5

$3,875.24 $4,172.83 $4,783.29 $5,893.67 $7,231.91

$3,471.67 $3,685.94 $4,125.47 $4,924.94 $5,888.48

Based on this data, and using regr ession analysis, determine the level of safety stocks that the firm appears to hold.

*

A. B. C. D. E.

$643.25 $675.10 $667.82 $681.50 $659.37

Run a regression on the HP10BII to determine beta: 3,875.24 4,172.83 4,783.29 5,893.67 7,231.91

Input Input Input Input Input

3,471.67 3,685.94 4,125.47 4,924.94 5,888.48

!+ !+ !+ !+ !+

0 "y,m = $681.50 = Intercept (safety stock) " SWAP

= 0.72 = Slope Coefficient = Beta (not needed for this problem)

YOU ARE GIVEN THE FOLLOWING INFORMA TION FOR QUESTIONS 26 - 29: Income Statement

Year 0


$1,500.00 -$1,275.00

Depreciation

-$

EBIT Interest EBT Taxes (40%)

Year 1 (1st)

Year 1 (2nd)

60.00

$ 165.00 -$

30.00

$ 135.00 -$

54.00


Page 39 of 57 Pages

Net Income

$

81.00

Dividends Paid Out

$

32.40

Assets

Year 0


$ 20.00 $ 200.00

Inventories

$ 240.00


$ 460.00 $1,200.00


Year 1 (2nd)

Year 1 (1st)

Year 1 (2nd)

-$ 560.00 $ 640.00 $1,100.00


Year 0


$ 150.00 $ 100.00

Accruals

$ 100.00


$ 350.00 $ 200.00 $ 372.00

Retained Earnings

$ 178.00


Year 1 (1st)

$1,100.00


*

Assume that the firm expects sales to increase by 20 percent in Year 1, that total assets, accounts payable, and accruals can be expressed as a percent of sales, and that the firm’s profit margin and dividend payout rate will remain the same as in Year 0. Based on this information, and using the equation m ethod, determine the firm’s additional funds needed for Year 1. A. B. C. D. E.

$127.74 $119.36 $111.68 $123.81 $115.49

AFN = (A*/S0)(!S) - (L*/S0)(!S) - (PM)(S1)(1-DPR) New Sales = ($1,500)*(1.20) = $1,800 Change in Sales = $1,800 - $1,500 = $300


Page 40 of 57 Pages

PM = $81 / $1,500 = 5.4% DPR = $32.40 / $81.00 = 40% AFN = ($1,100/$1,500)*($300) - ($250/$1,500)*($300) - (.054)*($1,800)*(1-.40) AFN = $220.00 - $50.00 - $58.32 = $111.68 Alternatively, since assets and liabilities will increase proportionately with sales: AFN = ($1,100)*(.20) - ($250)*(.20) - (.054)*($1,800)*(1-.40) AFN = $220.00 - $50.00 - $58.32 = $111.68 27.

Using a straight percent of sales forecasting method, you would forecast that inventories would increase to $312.00 in Year 1 if sales increase by 30 percent ($240*1.30 = $312). However, assume that the true relationship was determined by regression analysis to be as follows: Inventory = $112.50 + (0.085)(Sales) Based on this information, determine the difference in inventory levels forecasted by these two methods.

*

A. B. C. D. E.

$32.25 $35.25 $30.75 $29.25 $33.75

New Sales = ($1,500)*(1.30) = $1,950 Inventory = $112.50 + (0.085)($1,950) = $278.25 Difference = $312.00 - $278.25 = $33.75 28.


•

•

•

•

Sales will increase by 20 percent. Operating costs will decrease from 85 percent of sales down to 82 percent of sales. Cash, accounts receivable, inventories, accounts payable, and accruals can all be expressed as a percent of sales. The firm plans to add $400 to gross plan and equipment (fixed assets) at the beginning of Year 1. This additional plant and equipment will be depreciated on a straight line basis (no salvage value) over a 10-year life (that is, depreciation on the new equipment will be $40 per year), while the depreciation on the firm’s current equipment will remain at $60 per year. The firm has already made arrangements to increase its notes payable to $300 at the beginning of Year 1, while maintaining its long-term debt at $200. The interest rate on both of these will be 10 percent.


Page 41 of 57 Pages

•

The firm has already announced that its total dividend to be paid out will be increased by $7.00 in Year 1.

Given this information, do a first pass and determine the amount of additional funds needed for Year 1.

*

A. B. C. D. E.

$74.00 $80.00 $77.00 $71.00 $83.00 Year 1 (1st)

Income Statement

Year 0


$1,500.00 -$1,275.00

$1,800.00 -$1,476.00

Depreciation

-$

60.00

-$ 100.00

$ 165.00

$ 224.00

EBIT Interest EBT

-$

30.00

-$

$ 135.00

50.00

$ 174.00

Taxes (40%)

-$

54.00

Net Income

$

81.00

$ 104.40

Dividends Paid Out

$

32.40

$

Assets

Year 0


$ 20.00 $ 200.00

$ 24.00 $ 240.00

Inventories

$ 240.00

$ 288.00


$ 460.00 $1,200.00

$ 552.00 $1,600.00

-$ 560.00

-$ 660.00

$ 640.00

$ 940.00

$1,100.00

$1,492.00


Year 1 (2nd)

-$

69.60

39.40

Year 1 (1st)

Year 1 (1st)


Year 0


$ 150.00 $ 100.00

$ 180.00 $ 300.00

Accruals

$ 100.00

$ 120.00


$ 350.00 $ 200.00 $ 372.00

$ 600.00 $ 200.00 $ 372.00


Year 1 (2nd)

Year 1 (2nd)

Page 42 of 57 Pages

Retained Earnings Total Liabilities & Equity

$ 178.00

$ 243.00

$1,100.00

$1,415.00


*

$

77.00

Assume that you wish to use the spreadsheet method to forecast additional funds needed and have made the same assumptions as in Question #28 to determine the first-pass AFN for Year 1. Also assume now that the firm will raise these funds by issuing stock and that this, in turn, will cause the firm to increase its total dividend to be paid out to $41.75 in Year 1. Based on this information, determine what the additional funds needed will be if you now do a second pass. A. B. C. D. E.

$7.05 $3.95 $8.65 $2.35 $5.45

As discussed in class, the additional funds needed on a second pass will arise solely from financing feedback effects. The only financing feedback is that total dividends to be paid will increase by another $2.35, which will decrease the amount to be added to retained earnings by the same amount. Therefore, the AFN for the second pass will be $2.35 and no actual pass, first or second, is needed to solve the problem. However, to show that the answer is correct, a first and second pass would look like the following: Year 1 (1st)

Year 1 (2nd)

Income Statement

Year 0


$1,500.00 -$1,275.00

$1,800.00 -$1,476.00

$1,800.00 -$1,476.00

Depreciation

-$

60.00

-$ 100.00

-$ 100.00

$ 165.00

$ 224.00

$ 224.00

EBIT Interest EBT

-$

30.00

-$

$ 135.00

50.00

$ 174.00 -$

69.60

-$

50.00

$ 174.00

Taxes (40%)

-$

54.00

Net Income

$

81.00

$ 104.40

Dividends Paid Out

$

32.40

$

Assets

Year 0


$ 20.00 $ 200.00

$ 24.00 $ 240.00

$ 24.00 $ 240.00

Inventories

$ 240.00

$ 288.00

$ 288.00


$ 460.00 $1,200.00

$ 552.00 $1,600.00

$ 552.00 $1,600.00

39.40

Year 1 (1st)


-$

69.60

$ 104.40 $41.75 Year 1 (2nd)

Page 43 of 57 Pages


-$ 560.00

-$ 660.00

-$ 660.00

$ 640.00

$ 940.00

$ 940.00

$1,100.00

$1,492.00

$1,492.00

Year 1 (1st)

Year 1 (2nd)


Year 0


$ 150.00 $ 100.00

$ 180.00 $ 300.00

$ 180.00 $ 300.00

Accruals

$ 100.00

$ 120.00

$ 120.00


$ 350.00 $ 200.00 $ 372.00

$ 600.00 $ 200.00 $ 372.00

$ 600.00 $ 200.00 $ 449.00

Retained Earnings

$ 178.00

$ 243.00

$ 240.65

$1,100.00

$1,415.00

$1,489.65

$

$


77.00

2.35

YOU ARE GIVEN THE FOLLOWINGINFORMATION FOR Problems 30 - 31: Income Statement Sales Operating Costs Depreciation EBIT Interest EBT Taxes (40%) Net Income Dividends Paid Out

2006

2007 (1st)

2007 (2nd)

2007 (1st)

2007 (2nd)

$10,000.00 -$6,000.00 -$800.00 $3,200.00 -$400.00 $2,800.00 -$1,120.00 $1,680.00 $672.00

Assets

2006


$1,000.00 $3,000.00 $4,000.00


$8,000.00 $8,000.00 -$3,200.00

Net Plant & Equipment Total Assets

$4,800.00 $12,800.00


Page 44 of 57 Pages


2006

Accounts Payable Notes Payable Accruals

$2,500.00 $1,500.00 $1,000.00

Current Liabilities Long-Term Debt Common Stock Retained Earnings Total Liabilities & Equity

2007 (1st)

2007 (2nd)

$5,000.00 $2,500.00 $3,500.00 $1,800.00 $12,800.00


Now make the following assumptions: 1) 2) 3)

Sales are expected to increase by 20 percent in 2007 to a level of $12,000. All assets and spontaneous liabilities can be expressed as a percent of sales. In 2006 the tax rate was 40 percent, the profit margin was16.80 percent, and the dividend payout rate was 40.0 percent.

Using the equation method, and given the i nformation above, calculate the additional funds needed. *

A. B. C. D. E.

$650.40 $458.40 $602.40 $554.40 $506.40

A*/S0 = $12,800 / $10,000 = 128% L*/S0 = ($2,500 + $1,000) / $10,000 = 35% PM = $1,680 / $10,000 = 16.80% (1 - DPR) = 1 - .40 = 60% S1 = ($10,000) (1.20) = $12,000 !S

= $12,000 - $10,000 = $2,000

AFN = (1.28)($2,000) - (.35)($2,000) - ($12,000)(.168)(.6) AFN = $2,560 - $700 - $1,209.60 = $650.40 31.

Now make the following assumptions: 1)

Sales are expected to increase by 20 percent in 2007 to a level of $12,000.


Page 45 of 57 Pages

2) 3) 4)

5) 6) 7) 8) 9) 10) 11)

Fixed assets are being used at 90 percent of capacity. Fixed assets are lumpy. If the firm must add fixed assets, it must add a lumpsum of $2,000. Fixed assets are currently being depreciated on a straight line basis over a 10year period. New fixed assets will also be depreciated on a straight line basis over 10 years. In the future, the firm wishes to maintain its cash balance at a constant level of $1,000, regardless of the level of sales. All other assets and spontaneous liabilities can be expressed as a percent of sales and will grow proportionately with sales. The firm is obligated to pay back $500 of notes payable at the beginning of 2007. The before-tax interest rate on notes payable and long-term debt is, and will remain, at 10.0 percent. The tax rate will remain at 40 percent. The firm has already approved dividends of $828.00 for 2007. The firm has decided that any additional funds needed (AFN) will be raised as notes payable at an interest rate of 10.0 percent.

Using the spreadsheet method, and given the information above, do a first pass and calculate the additional funds needed, then do a second p ass, assuming that all funds are raised as notes payable, and determine the new level of additional funds needed.

*

A. B. C. D. E.

$71.64 $50.40 $64.57 $43.32 $57.48

Income Statement

2006

2007 (1st)

2007 (2nd)

Sales Operating Costs Depreciation EBIT Interest

$10,000.00 -$6,000.00 -$800.00 $3,200.00 -$400.00

$12,000.00 -$7,200.00 -$1,000.00 $3,800.00 -$350.00

$12,000.00 -$7,200.00 -$1,000.00 $3,800.00 -$445.80

EBT Taxes (40%)

$2,800.00 -$1,120.00

$3,450.00 -$1,380.00

$3,354.20 -$1,341.68

Net Income

$1,680.00

$2,070.00

$2,012.52

$672.00

$828.00

$828.00

Dividends Paid Out

2007 (1st)

2007 (2nd)

Assets

2006


$1,000.00 $3,000.00 $4,000.00

$1,000.00 $3,600.00 $4,800.00

$1,000.00 $3,600.00 $4,800.00


$8,000.00 $8,000.00

$9,400.00 $10,000.00

$9,400.00 $10,000.00


Page 46 of 57 Pages

Less: Depreciation

-$3,200.00

-$4,200.00

-$4,200.00


$4,800.00 $12,800.00

$5,800.00 $15,200.00

$5,800.00 $15,200.00

2007 (1st)

2007 (2nd)


2006

Accounts Payable Notes Payable Accruals Current Liabilities Long-Term Debt Common Stock Retained Earnings

$2,500.00 $1,500.00 $1,000.00 $5,000.00 $2,500.00 $3,500.00 $1,800.00

$3,000.00 $1,000.00 $1,200.00 $5,200.00 $2,500.00 $3,500.00 $3,042.00

$3,000.00 $1,958.00 $1,200.00 $6,158.00 $2,500.00 $3,500.00 $2,984.52

$12,800.00

$14,242.00

$15,142.52

$958.00

$57.48


As discussed in class, a second pass is not really needed, since any additional funds needed will arise solely from financing feedback effects: Original AFN = $958.00 = additional notes payable. Interest Expense = ($958.00)*(0.10) = $95.80 After-tax Interest Expens e = ($95.80)*(1-.40) = $57.48 = New AFN

32.

You are given the information listed below for your company. Now make the following assumptions: 1) 2) 3) 4)

5) 6) 7) 8) 9) 10)

Sales are expected to increase by 20 percent in 2007 to a level of $17,280. Fixed assets are being used at 90 percent of capacity. Fixed assets are lumpy. If the firm must add fixed assets, it must add a lumpsum of $3,000. Fixed assets are currently being depreciated on a straight line basis over a 10year period. New fixed assets will also be depreciated on a straight line basis over 10 years. In the future, the firm wishes to maintain its cash balance at a constant level of $1,000, regardless of the level of sales. All other assets and spontaneous liabilities can be expressed as a percent of sales and will grow proportionately with sales. The firm is obligated to pay back $1,000 of notes payable at the beginning of 2007. The before-tax interest rate on notes payable and long-term debt is, and will remain, at 10.0 percent. The tax rate will remain at 40 percent. The firm has already approved dividends of $1, 200.00 for 2007.


Page 47 of 57 Pages

11)

The firm has decided that any additional funds needed (AFN) will be raised as notes payable at an interest rate of 10.0 percent.

Using the spreadsheet method, and given the information above, do a first pass and calculate the additional funds needed, then do a second p ass, assuming that all funds are raised as notes payable, and determine the new level of additional funds needed. Income Statement Sales Operating Costs Depreciation EBIT Interest EBT Taxes (40%)

2006

$2,586.00

Dividends Paid Out

$1,000.00

Assets

2006


$1,440.00 $4,320.00 $5,760.00


$11,520.00 $10,000.00 -$4,000.00


$6,000.00 $17,520.00

Accounts Payable Notes Payable Accruals Current Liabilities Long-Term Debt Common Stock Retained Earnings Total Liabilities & Equity

2007 (2nd)

2007 (1st)

2007 (2nd)

2007 (1st)

2007 (2nd)

$14,400.00 -$8,640.00 -$1,000.00 $4,760.00 -$450.00 $4,310.00 -$1,724.00

Net Income


2007 (1st)

2006 $3,600.00 $2,000.00 $1,440.00 $7,040.00 $2,500.00 $3,500.00 $4,480.00 $17,520.00

Additional Funds Needed A. B. C.

$74.65 $77.65 $75.65


Page 48 of 57 Pages

*

D. E.

$78.65 $76.65

Income Statement Sales Operating Costs Depreciation

2006

2007 (1st)

2007 (2nd)

$14,400.00 -$8,640.00 -$1,000.00

$17,280.00 -$10,368.00 -$1,300.00

$17,280.00 -$10,368.00 -$1,300.00

$4,760.00 -$450.00

$5,612.00 -$350.00

$5,612.00 -$481.08

EBT Taxes (40%)

$4,310.00 -$1,724.00

$5,262.00 -$2,104.80

$5,130.92 -$2,052.37

Net Income

$2,586.00

$3,157.20

$3,078.55

Dividends Paid Out

$1,000.00

$1,200.00

$1,200.00

Assets

2006


$1,440.00 $4,320.00 $5,760.00

$1,000.00 $5,184.00 $6,912.00

$1,000.00 $5,184.00 $6,912.00


$11,520.00 $10,000.00 -$4,000.00

$13,096.00 $13,000.00 -$5,300.00

$13,096.00 $13,000.00 -$5,300.00


$6,000.00 $17,520.00

$7,700.00 $20,796.00

$7,700.00 $20,796.00

EBIT Interest

Liabilities & Equity Accounts Payable Notes Payable Accruals Current Liabilities Long-Term Debt Common Stock Retained Earnings Total Liabilities & Equity

2006 $3,600.00 $2,000.00 $1,440.00 $7,040.00 $2,500.00 $3,500.00 $4,480.00 $17,520.00

2007 (1st)

2007 (1st)

2007 (2nd)

2007 (2nd)

$4,320.00 $1,000.00 $1,728.00 $7,048.00 $2,500.00 $3,500.00 $6,437.20 $19,485.20

$4,320.00 $2,310.80 $1,728.00 $8,358.80 $2,500.00 $3,500.00 $6,358.55 $20,717.35

$1,310.80

$78.65


As discussed in class, a second pass is not really needed, since any additional funds needed will arise solely from financing feedback effects: Original AFN = $1,310.80 = additional notes payable. Interest Expense = ($1,310.80)*(0.10) = $131.08


Page 49 of 57 Pages

After-tax Interest Expens e = ($131.08)*(1-.40) = $78.65 = New AFN

33.


Assets

2007


2004

Current Assets Fixed Assets

$2,400,000 $1,600,000

Accounts Payable Accrued Wages Notes Payable Long-Term Debt Total Common Equity

$600,000 $400,000 $200,000 $1,000,000 $1,800,000

Total Assets

$4,000,000


$4,000,000

Now assume that in 2007, the company reported sales of $20 million, net income of $400,000, and dividends of $300,000. Also assume that (1) the company anticipates its sales will increase 20 percent in 2008, (2) its dividend payout will remain at 75 percent, and (3) the company is at full capacity, and that all of its assets and spontaneous liabilities will increase proportionately with an increase in sales. Finally, assume the company uses the AFN formula and all additional funds needed (AFN) will come from issuing new long-term debt. Given its forecast, and ignoring financing feedback effects, determine how much long-term debt the company will need to issue in 2008.

*

A. B. C. D. E.

$470,000 $500,000 $480.000 $510,000 $490,000

A*/S0 = $4,000,000 / $20,000,000 = 20% L*/S0 = ($600,000 + $400,000) / $20,000,000 = 5% PM = $400,000 / $20,000,000 = 2% (1 - DPR) = 1 - .75 = 25% S1 = ($20,000,000) (1.20) = $24,000,000 !S

= $24,000,000 - $20,000,000 = $4,000,000

AFN = (.2)($4,000,000) - (.05)($4,000,000) - ($24,000,000)(.02)(.25) AFN = $800,000 - $200,000 - $120,000 = $480,000

34.

You are given below the 2007 year-end financial statements for your firm and have been asked to project the firm’s funding needs for 2008. You may make the following assumptions when making your forecast:


Page 50 of 57 Pages

1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11.

Sales are expected to increase by 20 percent over the coming year -- they will increase to $12,000,000. Operating costs are expected to decrease to 58 percent of sales. The interest rate on long-term debt will remain at 10 percent for 2008, but the interest rate on short-term debt, such as notes payable, will go up to 12 percent. The tax rate, currently 35 percent, is expected to increase to 40 percent in 2008. The firm expects to maintain its dividend payout rate at 50 percent. All current assets will increase proportionately with sales. At the end of 2007, fixed assets (property plant and equipment) are being operated at only 90 percent of capacity. Fixed assets are lumpy. If the firm must increase its fixed assets, it will do so by adding an amount equal to $2,000. Currently, fixed assets are being depreciated on a straight-line basis over 10 years. Any new fixed assets will also be depreciated on a straight-line basis over a 10-year period. Accounts payable and accruals will increase proportionately with sales. Notes payable will decrease to $2,000 at the start of 2008.

You should now be able to do a “first pass” and determine the firm’s additional funds needed (AFN) for 2008. Now assume that the additional funds needed will be raised by issuing new equity, but that the firm will not change its dividend payout rate (i.e., there will be no financing feedback effects). Given this information, and considering the issuance of new equity, determine what the firm’s return on equity (ROE) is forecasted to be for 2008. Income Statement

2007

Sales Operating Costs Depreciation EBIT Interest EBT Taxes (35%/40%) Net Income Dividends Paid Out

$10,000.00 -$6,000.00 -$1,200.00 $2,800.00 -$600.00 $2,200.00 -$770.00 $1,430.00 $715.00

Assets

2007

Cash Accounts Receivable Inventories Current Assets Gross Plant & Equipment Less: Depreciation Net Plant & Equipment Total Assets

$1,000.00 $2,800.00 $4,000.00 $7,800.00 $12,000.00 -$4,800.00 $7,200.00 $15,000.00


2008 (1st) $12,000.00

2008 (1st)

2008 (2nd) $12,000.00

2008 (2nd)

Page 51 of 57 Pages

Liabilities & Equity Accounts Payable Notes Payable Accruals Current Liabilities Long-Term Debt Common Stock Retained Earnings Total Liabilities & Equity Additional Funds Needed

*

2007 $3,000.00 $4,000.00 $2,000.00 $9,000.00 $2,000.00 $3,500.00 $500.00 $15,000.00

2008 (1st)

2008 (2nd)

Income Statement

2007

2008 (1st)

2008 (2nd)

Sales Operating Costs Depreciation EBIT Interest EBT Taxes (35%/40%) Net Income Dividends Paid Out

$10,000.00 -$6,000.00 -$1,200.00 $2,800.00 -$600.00 $2,200.00 -$770.00 $1,430.00 $715.00

Assets

2007


$1,000.00 $2,800.00 $4,000.00 $7,800.00 $12,000.00 -$4,800.00 $7,200.00 $15,000.00


2007

A. B. C. D. E.

24.08% 26.82% 25.45% 29.56% 28.19%

Accounts Payable Notes Payable Accruals Current Liabilities

$3,000.00 $4,000.00 $2,000.00 $9,000.00


$12,000.00 -$6,960.00 -$1,400.00 $3,640.00 -$440.00 $3,200.00 -$1,280.00 $1,920.00 $960.00 2008 (1st) $1,200.00 $3,360.00 $4,800.00 $9,360.00 $14,000.00 -$6,200.00 $7,800.00 $17,160.00 2008 (1st) $3,600.00 $2,000.00 $2,400.00 $8,000.00

$12,000.00 -$6,960.00 -$1,400.00 $3,640.00 -$440.00 $3,200.00 -$1,280.00 $1,920.00 $960.00 2008 (2nd) $1,200.00 $3,360.00 $4,800.00 $9,360.00 $14,000.00 -$6,200.00 $7,800.00 $17,160.00 2008 (2nd) $3,600.00 $2,000.00 $2,400.00 $8,000.00

Page 52 of 57 Pages

Long-Term Debt Common Stock Retained Earnings Total Liabilities & Equity Additional Funds Needed

$2,000.00 $3,500.00 $500.00 $15,000.00

$2,000.00 $3,500.00 $1,460.00 $14,960.00 $2,200.00

$2,000.00 $5,700.00 $1,460.00 $17,160.00 $0.00

ROE = ($1,920) / ($5,700 + $1,460) = ($1,920 / $7,160) = 26.82%

35.

You are given the following financial statements for your company for Year 0: Income Statement Sales Operating Costs Depreciation EBIT Interest EBT Taxes (40%) Net Income Dividends Paid Out

Year 0 $8,000.00 -$4,800.00 -$600.00 $2,600.00 -$300.00 $2,300.00 -$920.00

Year 1 (1st)

Year 1 (2nd)

Year 1 (1 st)

Year 1 (2nd)

Year 1 (1st)

Year 1 (2nd)

$1,380.00 $552.00

Assets

Year 0


$800.00 $2,400.00 $3,200.00 $6,400.00 $6,000.00 -$2,400.00 $3,600.00 $10,000.00


Year 0


$2,000.00 $2,000.00 $800.00 $4,800.00 $1,000.00 $3,700.00 $500.00 $10,000.00


Page 53 of 57 Pages

Additional Funds Needed Now make the following assumptions: 1. 2. 3.

4. 5. 6. 7. 8.

Management expects sales to increase by 30 percent over the coming year to a level of $10,400. Operating costs during Year 1 will remain constant at 60 percent of sales. Current fixed assets (gross plant and equipment) are being depreciated on a straight-line basis over 10 years. Any new fixed assets purchase will be depreciated on a straight-line basis over 10 years. Fixed assets are currently being operated at only 80 percent of capacity and excess fixed assets cannot be s old. If additional fixed assets are needed, the firm will add $3,000 of fixed assets. Except for cash, which will go up to $1,000, current assets and spontaneous liabilities will increase proportionately with sales. The firm has already decided to pay total dividends next year of $600, regardless of whether it issues more shares of common stock. The current interest rate on long-term debt and notes payable is 10 percent. This is also the rate that the firm will pay if is issues additional long-term debt.

Do a first pass to determine additional funds needed for Year 1. Then assume that the additional funds needed will be raised in equal proportions of debt and equity. Do a second pass and determine the new additional funds that will now be needed.

*

A. B. C. D. E.

$50.55 $56.13 $47.76 $53.34 $58.92

Income Statement Sales Operating Costs Depreciation EBIT Interest EBT Taxes (40%) Net Income Dividends Paid Out Assets Cash Accounts Receivable Inventories Current Assets

Year 0 $8,000.00 -$4,800.00 -$600.00 $2,600.00 -$300.00 $2,300.00 -$920.00

Year 1 (1st) $10,400.00 -$6,240.00 -$900.00 $3,260.00 -$300.00 $2,960.00 -$1,184.00

Year 1 (2nd) $10,400.00 -$6,240.00 -$900.00 $3,260.00 -$398.20 $2,861.80 -$1,144.72

$1,380.00

$1,776.00

$1,717.08

$552.00

$600.00

$600.00

Year 0 $800.00 $2,400.00 $3,200.00 $6,400.00


Year 1 (1 st) $1,000.00 $3,120.00 $4,160.00 $8,280.00

Year 1 (2nd) $1,000.00 $3,120.00 $4,160.00 $8,280.00

Page 54 of 57 Pages

Gross Plant & Equipment Less: Depreciation Net Plant & Equipment Total Assets

$6,000.00 -$2,400.00 $3,600.00 $10,000.00


Year 0


$2,000.00 $2,000.00 $800.00 $4,800.00 $1,000.00 $3,700.00 $500.00 $10,000.00


$9,000.00 -$3,300.00 $5,700.00 $13,980.00 Year 1 (1st)

$9,000.00 -$3,300.00 $5,700.00 $13,980.00 Year 1 (2nd)

$2,600.00 $2,000.00 $1,040.00 $5,640.00 $1,000.00 $3,700.00 $1,676.00 $12,016.00

$2,600.00 $2,000.00 $1,040.00 $5,640.00 $1,982.00 $4,682.00 $1,617.08 $13,921.08

$1,964.00

$58.92

Alternatively, AFN on second pass co0me solely form financing feedback effects: Additional Interest = ($982.00)*(0.10) = $98.20 After-tax Interest Cost = ($98.20)*(1-.40) = $58.92

36.

You are given the following financial statements for your company for Year 0: Income Statement Sales Operating Costs Depreciation EBIT Interest EBT Taxes (40%) Net Income Dividends Paid Out Assets Cash Accounts Receivable Inventories Current Assets Gross Plant & Equipment

Year 0 $7,000.00 -$4,200.00 -$600.00 $2,200.00 -$300.00 $1,900.00 -$760.00

Year 1 (1st)

Year 1 (2nd)

Year 1 (1 st)

Year 1 (2nd)

$1,140.00 $456.00 Year 0 $700.00 $2,100.00 $2,800.00 $5,600.00 $6,000.00


Page 55 of 57 Pages


-$2,400.00 $3,600.00 $9,200.00


Year 0


Year 1 (1st)

Year 1 (2nd)

$1,750.00 $2,000.00 $700.00 $4,450.00 $1,000.00 $3,300.00 $450.00 $9,200.00

Additional Funds Needed Now make the following assumptions: 1. 2. 3.

4. 5. 6. 7. 8.

Management expects sales to increase by 30 percent over the coming year to a level of $9,100. Operating costs during Year 1 will remain constant at 60 percent of sales. Current fixed assets (gross plant and equipment) are being depreciated on a straight-line basis over 10 years. Any new fixed assets purchase will be depreciated on a straight-line basis over 10 years. Fixed assets are currently being operated at only 80 percent of capacity and excess fixed assets cannot be s old. If additional fixed assets are needed, the firm will add $3,000 of fixed assets. Except for cash, which will go up to $1,000, current assets and spontaneous liabilities will increase proportionately with sales. The firm has already decided to pay total dividends next year of $600, regardless of whether it issues more shares of common stock. The current interest rate on long-term debt and notes payable is 10 percent. This is also the rate that the firm will pay if is issues additional long-term debt.

Do a first pass to determine additional funds needed for Year 1. Then assume that the additional funds needed will be raised in equal proportions of debt and equity. Do a second pass and determine the new additional funds that will now be needed.

*

A. B. C. D. E.

$50.55 $56.13 $47.76 $53.34 $58.92

Income Statement Sales Operating Costs

Year 0 $7,000.00 -$4,200.00


Year 1 (1st) $9,100.00 -$5,460.00

Year 1 (2nd) $9,100.00 -$5,460.00

Page 56 of 57 Pages

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