Chapter 4 Financial Planning and Forecasting

CHAPTER 4 FINANCIAL 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 companys public financial statements and taxes paid also is higher. Actual taxes paid are determined from a companys tax filings. The difference between taxes actually paid, and taxes shown as being paid on a firms 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.

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Chapter 4 Financial Planning and Forecasting 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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Chapter 4 Financial Planning and Forecasting

SOLUTIONS TO PROBLEMS:
1. ATCF = EAT + Depreciation + Deferred taxes = $650,000 + $400,000 + $100,000 = $1,150,000 2. Midland Manufacturing Corporation Statement of Cash Flows For the Year Ended December 31, 2010 ($ millions)

Cash Flows from Operating Activities: Net income Adjustments to reconcile net income to net cash provided from operating activities Depreciation (Increase) decrease in current assets or liabilities Accounts receivable Inventories Accounts payable Other current liabilities Increase (decrease) in deferred taxes Total adjustments Net cash provided from (used by) operating activities Cash Flows from Investing Activities Proceeds from sale of facilities or equipment Capital expenditures ($115.0 - $80.7 + $1.0) Net cash used by investing activities Cash Flows from Financing Activities Proceeds from issuance of long-term debt Repayments of long-term debt Dividends paid Net cash provided from (used by) financing activities Net Increase (Decrease) in Cash

$8.3

9.5 (0.3) (0.7) 1.5 2.2 0.2 12.4 20.7

1.0 (35.3) (34.3)

15.0 (2.0) (3.5) 9.5 (4.1)

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Chapter 4 Financial Planning and Forecasting Cash - Beginning of Year Cash - End of Year 4.9 $0.8

3. a. Additional Financing = [(A/S)(S) - (CL/S)(S)] - [EAT - D] Needed A = $7,500,000 S = $3,750,000 S = $15,000,000 D = $250,000 CL = $1,500,000

EAT = $18,750,000 - $18,000,000 = $750,000 Additional Financing = [(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 Sheet as of December 31, 2011 Assets Cash $1,875,000 $ 625,000 2,500,000 5,000,000 8,125,000 1,250,000 $9,375,000 Liabilities Accounts payable Notes payable Total Cur. Liabilities Long-term Debt Stockholders' equity Total liabilities and equity 2,000,000 3,875,000 500,000 5,000,000

Accounts Receivable Inventories Total Cur. Assets Fixed assets, net Total assets $9,375,000

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Chapter 4 Financial Planning and Forecasting Income Statement for the Year Ending December 31, 2011 Sales Expenses, including interest and taxes EAT Dividends Addition to retained earnings Selected Financial Ratios Current ratio Debt ratio Rate of return on stockholders equity Net profit margin on sales (EAT/Sales) Part Add. Financing Needed Balance Sheet as of Dec. 31, 2011 Assets Cash Accounts receivable Inventories Tot. cur. assets Fixed assets, net Total assets Liabilities and equity Accounts payable $1,800,000 $ 600,000 2,400,000 4,800,000 7,800,000 1,200,000 $9,000,000 b. $1,950,000 $ 650,000 2,600,000 5,200,000 8,450,000 1,300,000 $9,750,000 c. b. $500,000 c. $800,000 2.10 times 46.7% 15.0% 4.0% $18,750,000 18,000,000 750,000 250,000 $500,000

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Notes payable Tot. cur. liab. Long-term debt

Chapter 4 Financial Planning and Forecasting 1,500,000 1,800,000 3,300,000 500,000 5,200,000 $9,000,000 3,750,000 500,000 5,500,000 $9,750,000

Stockholders' equity Total liabilities and equity

Income Statement for Year Ending Dec. 31, 2011 Sales Expenses, including interest & taxes EAT Dividends Additions to retained earnings $18,000,000 $19,500,000 17,050,000 950,000 250,000 18,250,000 1,250,000 250,000

$700,000 $1,000,000

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

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Chapter 4 Financial Planning and Forecasting 4. Atlas Products Inc. Cash Budget Worksheet First Quarter, 2010 December January February March

Estimated Sales $825,000 $730,000 $840,000 $920,000 Estimated Credit Sales 770,000 690,000 780,000 855,000 Estimated Receipts: Cash sales 40,000 60,000 65,000 Collections of Accounts Receivable 75% of last months 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 $438,000 504,000 552,000 438,000 504,000 552,000

Estimated payments of accounts payable

Cash Budget First Quarter, 2010 December January Sales Projected cash balance beginning of month February March $920,000 $100,000

$825,000 $730,000 $840,000 $100,000 $100,000

Receipts: Cash sales Collection of accounts receivable Total cash available

40,000 750,000 $890,000

60,000 712,500 872,500

65,000 798,750 963,750

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Chapter 4 Financial Planning and Forecasting

Disbursements: Payment of accounts payable $438,000 $504,000 Wages and salaries 250,000 290,000 Rent 27,000 27,000 Other expenses 10,000 12,000 Taxes 105,000 --Dividends on common stock ----Purchase of new equipment (capital budget) --75,000 Total disbursements Excess of available cash over disbursements Cash loans needed to maintain balance of $100,000 Projected cash balance, end of month $830,000 $908,000 $60,000 ($35,500) $552,000 290,000 27,000 14,000 --40,000 --$923,000 $40,750

40,000 $100,000

135,500

59,250

$100,000 $100,000

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

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Chapter 4 Financial Planning and Forecasting

5.

Elmwood Manufacturing Company Cash Budget Worksheet First Quarter, 2011 December January February $11,200,000 March April

Estimated Sales (all on credit)

$4,600,000 $6,400,000

$8,400,000 $7,000,000

Estimated Receipts 60% of last months sales 40% of current months sales Total A/R Collections Estimated Purchases * Estimated Payments**

---

2,760,000 2,560,000 5,320,000

3,840,000 4,480,000 8,320,000 2,520,000 3,360,000

6,720,000 3,360,000 10,080,000 -2,520,000

---

1,920,000 --

3,360,000 1,920,000

--

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

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Chapter 4 Financial Planning and Forecasting

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Chapter 4 Financial Planning and Forecasting Cash Budget First Quarter, 2011 December $4,600,000 January $6,400,000 February $11,200,000 March $8,400,000 April $7,000,000

Sales Projected cash balance, beginning of month Receipts: Collection of A/R Total cash available

$1,500,000 5,320,000 $6,820,000

$750,000

$750,000

8,320,000 10,080,000 $9,070,000 $10,830,000

Disbursements Payments of A/P Labor expenses Factory overhead Selling and adm. Expenses Taxes Dividends Purchase of new equipment Total disbursements Excess of available cash over disbursements Incremental cash loans needed to maintain a balance of $750,000 Loan repayment Projected cash balance, end of month

$1,920,000 3,920,000 650,000 1,275,000 $7,765,000

$3,360,000 2,940,000 670,000 1,285,000 1,500,000 $9,755,000

$2,520,000 2,450,000 670,000 1,310,000 1,600,000 650,000 $9,200,000

($945,000)

($685,000) $1,630,000

$1,695,000 0 $750,000

$1,435,000 0 $750,000

$880,000 $750,000

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Chapter 4 Financial Planning and Forecasting

6.

Podrasky Corporation Pro Forma Statement of Cash Flows ($ millions)

Cash Flows from Operating Activities: Net income Adjustments to reconcile net income to net cash provided from operating activities Depreciation (Increase) decrease in current assets or liabilities Accounts receivable Inventories Total adjustments Net cash provided from (used by) operating activities

$80

80 (20) (20) 40 120

Cash Flows from Investing Activities Capital expenditures Net cash used by investing activities Cash Flows from Financing Activities Additional financing Repayments of long-term debt Dividends paid Required increase in cash balance Net cash provided from (used by) financing activities

(200) (200)

X (10) (15) (3) (28) + X

In this problem, the expected cash flows must equal zero. Therefore, $120 - $200 - 28 + X = 0 X = $108 Therefore, the additional financing required is $108 million.

7. a. A = $2,300,000

S = $4,000,000

S = $2,000,000

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Chapter 4 Financial Planning and Forecasting D = $50,000 EAT = $400,000 CL = $600,000 Additional Financing = [(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

Pro Forma Balance Sheet as of Dec. 31, 2011 Assets Liabilities Cash $300,000 Accounts Payable $900,000 Accounts Receivable 600,000 Notes Payable 1,000,000 Inventories 1,800,000 Long-term Debt 200,000 Fixed 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 projected sales increase, assuming a 60-day average collection period is $2,000,000 x (60/365) = $328,767 The 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 = $1,687,500 The pro forma current liabilities before any additional financing is $1,400,000 (i.e., A/P = $900,000 and N/P = $500,000). Therefore a

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Chapter 4 Financial Planning and Forecasting maximum 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.

8.

Table 4-4 Example Additional Financing = [(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 Additional

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

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 Additional

EAT = 18,000,000 - 17,050,000 = $950,000

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

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Chapter 4 Financial Planning and Forecasting

c.

S = $4,500,000 Additional

EAT = 19,500,000 - 18,250,000 = $1,250,000

Financing = [(6,500,000/15,000,000)(4,500,000) Needed - (1,500,000/15,000,000)(4,500,000)] - [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 = $35 Therefore, external financing required is $75 (capital expenditures) minus $35 $40 million. (available funds) or

10.

Sales growth = 50 percent Cash growth = +$2 Accounts receivable growth = +$5 Inventory growth = +$7.5 Net fixed asset growth = +$10 Accounts payable growth = +$3 EAT = $10 Dividends = $1 External financing needed = +2 + 5 + 7.5 + 10 - 3 - (10 - 1)

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Chapter 4 Financial Planning and Forecasting = $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.

11. No recommended solution

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