INSTITUTE OF BUSINESS MANAGEMENT

Assignment – Spring 2020

Course Title: Strategic Financial Analysis & Design Course Code: FIN601
Faculty: Syed Misbah Maqbool Section: E-5954
Day / Date: Thursday/Mar. 26, 2020 Timings:
Student’s Name Total Marks:
Student ID:
Note:

Question 1) THEORETICAL
a) Why should companies use a project’s net cash flows rather than its accounting income
when determining a project’s NPV?

b) Define each of the following terms:

Project cash flow; accounting income; Incremental cash flow; sunk cost; opportunity cost;
cannibalization.

Question 2) MINI CASE

Greenfield Office Supplies’ stock price had been lagging its industry averages, so its board of
directors brought in a new CEO, Richard James. James asked for the company’s long-run
strategic plan; when he learned that no formal plan existed, he decided to develop one himself.
James had brought in Adam Smith, a finance MBA who had been working for a consulting
company, to replace the old CFO, and he asked Adam to develop the financial planning section
of the strategic plan. In his previous job, Smith’s primary task had been to help clients develop
financial forecasts, and that was one reason James hired him.
Smith began as he always did, by comparing Greenfield’s financial ratios to the industry
averages. If any ratio was substandard, he discussed it with the responsible manager to see
what could be done to improve the situation. Greenfield’s latest financial statements plus some
ratios and other data that Smith plans to use in his analysis are provided at the end of this case.
Smith learned back in his university days that, because of interactions among variables, any
realistic financial forecast must be based on a computer model. Of course, he is also aware of
the well-known computer axiom—garbage in, garbage out (GIGO). Smith therefore plans to
discuss the model’s inputs carefully with Greenfield’s operating managers, individually and also
collectively in the company’s financial planning conference.

a. Given the data at the end of case, how well run would you say Greenfield appears to be in
comparison with other firms in its industry? What are its primary strengths and weaknesses? Be
specific in your answer, and point to various ratios that support your position.
b. Use the AFN equation to estimate Greenfield’s required new external capital for 2011 if the
15% expected growth takes place. Assume that the firm’s 2010 ratios will remain the same in
2011.

c. Based on the end of case data, what is Greenfield’s self-supporting growth rate?

d. Forecast the financial statements for 2011 using the following assumptions. (1) Operating
ratios remain unchanged. (2) No additional notes payable, LT bonds, or common stock will be
issued. (3) The interest rate on all debt is 10%. (4) If additional financing is needed, then it will
be raised through a line of credit. The line of credit would be tapped on the last day of the year,
so it would create no additional interest expenses for that year. (5) Interest expenses for notes
payable and LT bonds are based on the average balances during the year. (6) If surplus funds
are available, the surplus will be paid out as a special dividend payment. (7) Regular dividends
will grow by 15%. (8) Sales will grow by 15%. We call this the Steady scenario because
operations remain unchanged.

1. How much new capital will the firm need (i.e., what is the forecasted AFN)?

2. Calculate the firm’s free cash flow, return on invested capital, EPS, DPS, ROE, and any
other ratios you think would be useful in considering the situation.

3. Calculate the firm’s Cash Conversion Cycle for year 2010.

Financial Statements and Other Data (Millions, Except for Per Share Data)

Balance Sheet, Greenfield, 12/31/10 $ in mln Income Statement, Greenfield, 2010 $ in mln
Cash and securities 20 Sales 2000
Accounts receivable 290 Total operating costs 1900
Inventories 390 EBIT 100
Total current assets 700 Interest 60
Net fixed assets 500 EBT 40
Total assets 1,200 Taxes (40%) 16
Net income 24
Accounts pay. + accruals 100 Dividends 9
Notes payable 80 Add’n to retain. earnings 15
Total current liabilities 180
Long-term debt 520 Shares outstanding in mln. 10
Total liabilities 700 EPS $ 2.40
Common stock 300 DPS $ 0.90
Retained earnings 200 Year-end stock price $ 24.00
Total common equity 500
Total liab. & equity 1,200

Selected Ratios and Other Data, 2010 Greenfield Industry

Sales, 2010 (S0 ) $ 2,000 $ 2,000

Expected growth in sales: 15% 15%
Profit margin (M): 1.2% 2.74%
Assets/Sales (A0 /S0 ): 60% 50%
Payout ratio (POR): 37.5% 35%
Equity multiplier (Assets/Equity): 2.4 2.13
Total liability/Total assets 58.3% 53%
Times interest earned (EBIT/Interest): 1.67 5.20
Increase in sales (ΔS = gS0 ): $ 300 $ 300
(Payables + Accruals)/Sales (L 0 /S0 ) 5% 4%
Operating costs/Sales: 95% 93%
Cash/Sales: 1.0% 1%
Receivables/Sales: 14.5% 11%
Inventories/Sales: 19.5% 15%
Fixed assets/Sales: 25.0% 23%
Tax rate: 40% 40%
Interest rate on all debt: 10% 9.5%
Price/Earning (P/E): 10.00 12.00
ROE (Net income/Common equity): 4.80% 11.64%

Note: Greenfield was operating at full capacity in 2010.

FORMULAE SHEET