cfm10e_aiseIM04rev
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 company’s public financial statements and “taxes paid” also is higher. A ctual taxes paid are determined from a company’s tax filings. The difference between taxes “actually” paid, and taxes shown as being paid on a firm’s public financial statements is recorded as deferred taxes on the right-hand side of the balance sheet.
2. Pro forma financial statements are financial statements that project the results of some assumed events rather than actual events. The assumed events do not necessarily have to be future events; for example, a company considering acquiring another company will usually prepare pro forma statements assuming the two companies had been merged for the past couple of years.
3. The percentage of sales forecasting method is a method of estimating the additional financing that will be needed to support a given future sales level. Financial analysts should be aware that the method assumes that as a company's sales increase, its assets are also assumed to increase proportionately to support the new sales. In addition, the current liabilities that vary directly with sales are also assumed to increase proportionately with the new sales. These assumptions may not hold in many actual financial planning situations.
4. A cash budget is a projection of a company's cash receipts and disbursements over some future period of time. Normally a worksheet is prepared, showing expected receipts and disbursements over the time period. Then, the receipts and disbursements figures (normally, monthly) are combined to determine when the company will require short-term financing and when it will have excess cash.
5. The statement of cash flows can be used to estimate how much external financing a company will need in some future period by estimating the other cash flows of the company for the period (see Problem 16).
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).
SOLUTIONS TO PROBLEMS:
1. ATCF = EAT + Depreciation + Deferred taxes
= $650,000 + $400,000 + $100,000
= $1,150,000
2. Summit Furniture Company Statement of Cash Flows
For the Year Ended December 31, 2005
Increase (Decrease) in Cash and Cash Equivalents (000) Cash Flows from Operating Activities:
Cash received from customers $142,000
Cash paid to suppliers and employees (120,000)
Interest received 600
Interest paid (net of amount capitalized) (2,000)
Income taxes paid (6,000)
Net cash provided (used) by operating activities $14,600 Cash Flows from Investing Activities:
Proceeds from sale of asset $1,000
Capital expenditures (22,000)
Net cash provided (used) by investing activities ($21,000) Cash Flows from Financing Activities
Net borrowings under bank line-of-credit agreement $1,000
Repayments of long-term debt (2,600)
Proceeds from issuance of long-term debt 4,000
Dividends paid (800)
Net cash provided (used) by financing activities $1,600 Net increase (decrease) in cash and cash equivalents ($4,800) Cash and cash equivalents at beginning of year 5,000 Cash and cash equivalents at end of year $200
3. Midland Manufacturing Corporation
Statement of Cash Flows For the Year Ended December 31, 2002 ($ millions)
Cash Flows from Operating Activities:
Net income $8.3 Adjustments to reconcile net income to net cash provided
from operating activities
Depreciation 9.5 (Increase) decrease in current assets or liabilities
Accounts receivable (0.3)
Inventories (0.7)
Accounts payable 1.5
Other current liabilities 2.2 Increase (decrease) in deferred taxes 0.2
Total adjustments 12.4
Net cash provided from (used by) operating activities 20.7
Cash Flows from Investing Activities
Proceeds from sale of facilities or equipment 1.0
Capital expenditures ($115.0 - $80.7 + $1.0) (35.3)
Net cash used by investing activities (34.3)
Cash Flows from Financing Activities
Proceeds from issuance of long-term debt 15.0 Repayments of long-term debt (2.0) Dividends paid (3.5)
Net cash provided from (used by) financing activities 9.5
Net Increase (Decrease) in Cash (4.1)
Cash - Beginning of Year 4.9
Cash - End of Year $0.8
4.(Actual)
(Pro Forma)
Balance Sheet December 31, 2006 December 31, 2007
Assets
Cash $ 500,000 $ 650,000
Accounts Receivable 2,000,000 2,600,000
Inventory 4,000,000 5,200,000
Total Current Assets $ 6,500,000 $ 8,450,000
Fixed assets, net $ 1,000,000 $ 1,300,000
Total Assets $ 7,500,000 $ 9,750,000
Liabilities and Equity
Accounts Payable (CL) $ 1,500,000 $ 1,950,000
Notes Payable 1,000,000 1,000,000
Total Current Liabilities $ 2,500,000 $ 2,950,000
Long-term Debt 500,000 2,050,000 Stockholders’ Equity 4,500,000 4,750,000
Total Liabilities &
Stockholders’ Equity $ 7,500,000 $ 9,750,000
Income Statement 2006 2007________ Sales $15,000,000 $19,500,000
Expenses (including Interest
and Taxes) 14,250,000 18,750,000
Earnings after taxes (EAT) $ 750,000 $ 750,000
Dividends paid (D) 250,000 500,000
Retained Earnings $ 500,000 $ 250,000
Selected Financial Ratios______________________________________
Current Ratio 2.60 times 2.86 times
Debt Ratio 40% 51.3%
16.7% 15.8%
NPM 5.0% 3.8%
Additional Financing Needed = Additions to Assets – Additions to Current Liabilities –
Retained Earnings
= $2,250,000 - $450,000 - $250,000 = $1,550,000
= Increase in Long-term Debt
Problem #5 follows on the next 2 pages
E s t i m a t e d S a l e s : E s t i m a t e d C r e d i t S a l e s : E s t i m a t e d R e c e i p t s : C a s h S a l e s C o l l e c t i o n s o f a c c o u n t s r e c e i v a b l e 75% o f l a s t m o n t h 's c r e d i t s a l e s 25% o f c u r r e n t m o n t h 's c r e d i t s a l e s T o t a l A /R c o l l e c t i o n s E s t i m a t e d P u r c h a s e s : * E s t i m a t e d P a y m e n t s o f A c c o u n t s P a y a b l e : **
A t l a s P r o d u c t s , I n c .
C a s h B u d g e t W o r k s h e e t
F i r s t Q u a r t e r , 19X 2
D e c e m b e r $825,000 770,000 $438,000 J a n u a r y $730,000 690,000 40,000 577,500 172,500 $750,000 504,000 $438,000 F e b r u a r y $840,000 780,000 60,000 517,500 195,000 $712,500 552,000 $504,000 M a r c h $920,000 855,000 65,000 585,000 213,750 $798,750 $552,000
Cash Budget
First Quarter, 2006
December January February March Sales $825,000 $730,000 $840,000 $920,000 Projected cash balance
beginning of month $100,000 $100,000 $100,000 Receipts:
Cash sales 40,000 60,000 65,000 Collection of accounts receivable 750,000 712,500 798,750 Total cash available $890,000 872,500 963,750 Disbursements:
Payment of accounts payable $438,000 $504,000 $552,000 Wages and salaries 250,000 290,000 290,000 Rent 27,000 27,000 27,000 Other expenses 10,000 12,000 14,000 Taxes 105,000 --- ---Dividends on common stock --- --- 40,000 Purchase of new equipment (capital budget) --- 75,000 ---Total disbursements $830,000 $908,000 $923,000 Excess of available cash over $60,000 ($35,500) $40,750 disbursements
Cash loans needed to maintain
balance of $100,000 40,000 135,500 59,250 Projected cash balance, end of month $100,000 $100,000 $100,000 * Purchases are estimated at 60% of next month’s sales.
** Payments are estimated to lag purchases by one month
6. Elmwood Manufacturing Company
Cash Budget Worksheet
First Quarter, 2007
December January February March April Estimated Sales $4,600,000 $6,400,000 $11,200,000 $8,400,000 $7,000,000 (all on credit)
Estimated Receipts
60% of last month’s sales-- 2,760,000 3,840,000 6,720,000 -- 40% of current month’s sales-- 2,560,000 4,480,000 3,360,000 -- Total A/R Collections 5,320,000 8,320,000 10,080,000 Estimated Purchases * 1,920,000 3,360,000 2,520,000 -- -- Estimated Payments** -- 1,920,000 3,360,000 2,520,000
* 30% of next month’s estimated sales
** Payments lag purchases by one month
Cash Budget
First Quarter, 2007
December January February March April Sales $4,600,000 $6,400,000 $11,200,000 $8,400,000 $7,000,000 Projected cash
balance, beginning
of month $1,500,000 $750,000 $750,000
Receipts:
Collection of A/R 5,320,000 8,320,000 10,080,000
Total cash available $6,820,000 $9,070,000 $10,830,000 Disbursements
Payments of A/P $1,920,000 $3,360,000 $2,520,000
Labor expenses 3,920,000 2,940,000 2,450,000
Factory overhead 650,000 670,000 670,000
Selling and adm. Expenses 1,275,000 1,285,000 1,310,000
Taxes - - 1,600,000
Dividends - - 650,000
Purchase of new equipment - 1,500,000 -
Total disbursements $7,765,000 $9,755,000 $9,200,000
Excess of available cash
over disbursements ($945,000) ($685,000) $1,630,000 Incremental cash loans needed
to maintain a balance of
$750,000 $1,695,000 $1,435,000 -
Loan repayment 0 0 $880,000
Projected cash balance,
end of month $750,000 $750,000 $750,000
7. Podrasky Corporation
Pro Forma Statement of Cash Flows ($ millions)
Cash Flows from Operating Activities:
Net income $80 Adjustments to reconcile net income to net cash provided
from operating activities
Depreciation 80 (Increase) decrease in current assets or liabilities
Accounts receivable (20)
Inventories (20)
Total adjustments 40
Net cash provided from (used by) operating activities 120 Cash Flows from Investing Activities
Capital expenditures (200)
Net cash used by investing activities (200) Cash Flows from Financing Activities
Additional financing X Repayments of long-term debt (10) Dividends paid (15) Required increase in cash balance (3)
Net cash provided from (used by) financing activities (28) + X In this problem, the expected cash flows must equal zero. Therefore, $120 - $200 - 28 + X = 0
X = $108
Therefore, the additional financing required is $108 million.
8. a. A = $2,300,000 S = $4,000,000 ?S = $2,000,000
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, 2009
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
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.
9. a. AFN = (A/S)(?S) ? (CL/S)(?S) ? (Forecasted EAT ? Forecasted Dividends)
= ($12,000,000/$10,000,000)($2,500,000)
–($1,500,000/$10,000,000)($2,500,000) ? ($1,250,000 ? $312,500)
= $3,000,000 ? $375,000 ? $937,500
= $1,687,500
b. The new asset level = (1.25)($8,000,000) + (1.40)($4,000,000)
= $15,600,000, or $600,000 more than required in part (a)
Additional assets needed = $15,600,000 ? $12,000,000 = $3,600,000
AFN = $3,600,000 ? $375,000 ? $937,500
= $2,287,500
10. Required additional assets for next year = $50 million fixed assets + $10 million current assets
= $60 million additional assets
Financing supplied by Accounts Payable and Accruals = $5 million
Financing supplied by Retained Earnings = $6 million
AFN = $60 million - $5 million - $6 million
= $49 million
11. 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)
= $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.
12. No recommended solution