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Chapter 14 Financial Planning and Forecasting Pro Forma Financial Statements

ANSWERS TO END-OF-CHAPTER QUESTIONS
14-1 a. The operating plan provides detailed implementation guidance designed to accomplish corporate objectives. It details who is responsible for what particular function, and when specific tasks are to be accomplished. The financial plan details the financial aspects of the corporation’s operating plan. In addition to an analysis of the firm’s current financial condition, the financial plan normally includes a sales forecast, the capital budget, the cash budget, pro forma financial statements, and the external financing plan. A sales forecast is merely the forecast of unit and dollar sales for some future period. Of course, a lot of work is required to produce a good sales forecast. Generally, sales forecasts are based on the recent trend in sales plus forecasts of the economic prospects for the nation, industry, region, and so forth. The sales forecast is critical to good financial planning. b. A pro forma financial statement shows how an actual statement would look if certain assumptions are realized. With the percent of sales forecasting method, many items on the income statement and balance sheets are assumed to increase proportionally with sales. As sales increase, these items that are tied to sales also increase, and the values of these items for a particular year are estimated as percentages of the forecasted sales for that year. c. Funds are spontaneously generated if a liability account increases spontaneously (automatically) as sales increase. An increase in a liability account is a source of funds, thus funds have been generated. Two examples of spontaneous liability accounts are accounts payable and accrued wages. Note that notes payable, although a current liability account, is not a spontaneous source of funds since an increase in notes payable requires a specific action between the firm and a creditor.

Answers and Solutions: 14 - 1

d. Additional funds needed (AFN) are those funds required from external sources to increase the firm’s assets to support a sales increase. A sales increase will normally require an increase in assets. However, some of this increase is usually offset by a spontaneous increase in liabilities as well as by earnings retained in the firm. Those funds that are required but not generated internally must be obtained from external sources. Although most firms’ forecasts of capital requirements are made by constructing pro forma income statements and balance sheets, the AFN formula is sometimes used to forecast financial requirements. It is written as follows: Additional Required Spontaneou s Increase in funds = increase − increase in − retained needed in assets liabilities earnings  A∗   ∗  ∆S −  L  ∆S − MS1 (1 − d ). AFN =   S   S      Capital intensity is the dollar amount of assets required to produce a dollar of sales. The capital intensity ratio is the reciprocal of the total assets turnover ratio. e. “Lumpy” assets are those assets that cannot be acquired smoothly, but require large, discrete additions. For example, an electric utility that is operating at full capacity cannot add a small amount of generating capacity, at least not economically. 14-2 14-3 14-5 Accounts payable, accrued wages, and accrued taxes increase spontaneously and proportionately with sales. Retained earnings increase, but not proportionately. The equation gives good forecasts of financial requirements if the ratios A*/S and L*/S, as well as M and d, are stable. Otherwise, another forecasting technique should be used. a. +. b. +. It reduces spontaneous funds; however, it may eventually increase retained earnings. c. +. d. +.

Answers and Solutions: 14 - 2

000.000) .000. A2004 = $1.000 .000.000  = (0.6)($1.000. PM = 5%.000)(1 .$190.000)(0. therefore. The capital intensity ratio is measured as A*/S0.$90. d = 60%.000 = $800.$100.3 .000.$100.000  = (0.000.8)($1.500.1)($1.000. 14-2 14-3 AFN = (0.000.1)($1.000.000 = $200.6)($1.000 = $410.3) = $600.000   $500.000.000   $5.1)($1. Answers and Solutions: 14 . Accruals2004 = $100.000 .0. A/P2004 = $200.3) AFN =   $5.000.05($6.000.000.000.000 .000   $1.(0.000 .75.000) .000 . NP2004 = $200.000.000 .000.SOLUTIONS TO END-OF-CHAPTER PROBLEMS 14-1 AFN = (A*/S0)∆S .000.$90.000 – (0. Under this scenario the company would have a higher level of retained earnings which would reduce the amount of additional funds needed.000) .(0.($300.000. A*/S0 = 0. CL2004 = $500.7) =  $5.000) – ($300.0.000   $1.000)(0.$100.(L*/S0)∆S .000.000.000) .$300.000.000 . 14-4 S2004 = $2.000.000.000)(1 .  $4.000) .0) = $600.  $1.05($6.000.000 = $610.000.0.000. this firm is more capital intensive--it would require a large increase in total assets to support the increase in sales.000 . This firm’s capital intensity ratio is higher than that of the firm in Problem 14-1.MS1(1 .d)  $3.

02)S1 = 0.02)S1 = 0.6) = (0.MS1(1 . Sales can increase by $2.$2.(0.000 = $68.75)∆S .000 .0.02S1 $1. Answers and Solutions: 14 .000.000.000   ∆S -(0.  $2.000 = 0.5 $10.6(S1 .6S1 . AFN = (A*/S)(∆S) – (L*/S)(∆S) – MS1(1 – d) $122.200.d)  $300.02)S1 = 0.(0.(0.AFN = (A*/S0)∆S .58S1 $2.6(S1 .(0. 14-5 a.6)∆S .(L*/S0)∆S . $350 $350 $350 Upton Computers Pro Forma Balance Sheet December 31.52 = S1.6) = $13.965.$1.52 .02)S1 = (0.000  = (0.000) .068.44 million.5 = ($70) ($70) ($420)(0.965. 2005 (Millions of Dollars) Forecast Pro Forma Basis % after 2004 2005 Sales Additions Pro Forma Financing Financing b.52 without additional funds being needed.5 $17.15)∆S .05)(S1)(1 .$2.068.000.75)∆S .4 .S0) .0.965.200.(0.

44 $ 4.00 10.6) = 0.5/$350 = 3%.0257 0.56 $133.00 73.44 10.0 $122.2 × 0.5 .5 $ 9.5 0. NI = $350 × 1.00 $147.0 66.5 26.6.60 $105.DIV = $12.5 $ 35.1660 0.00 $ 10.0243 $ 4.20 69.0100 0. Addition to RE = NI .00 $147.00 42.5 6.0 8.44 6.2/$10.56* 15.00 7.5 = 40%.56 $ 13.6($12.20 31.44 15.56.03 = $12.0 15.60 $105.00 $ 10.56 $147.0 $122. and equity AFN = $ 3. Answers and Solutions: 14 .00 6.20 $ 52.20 31.80 31.6) = $7.00 42.0 18.00 +13.6 .Cash Receivables Inventories Total current assets Net fixed assets Total assets Accounts payable Notes payable Accruals Total current liabilities Mortgage loan Common stock Retained earnings Total liab.5 35.7430 0.20 69.0 58.80 18.00 73.0 $ 87.20 $ 39.00 *PM = $10. Payout = $4.0.4($12.100 0.

166 Stevens Textiles Pro Forma Balance Sheet Answers and Solutions: 14 .000 $32.6 .240 $ 1.094 0. Stevens Textiles Pro Forma Income Statement December 31.9011 × Sales05 37.10 × Debt04 560 $ 3.14-6 a.100 1.860 $ 837 $ 1.560 460 $ 3.440 $ 3.414 $ 2.306 $ 4.15 × Sales04 $41. 2005 (Thousands of Dollars) Sales Operating costs EBIT Interest EBT Taxes (40%) Net income Dividends (45%) Addition to RE 2004 $36.120 $ 954 $ 1.023 Forecast Pro Forma Basis 2005 1.534 1.400 0.

1883 9.026 $31.560 12.000 3.911 × Sales05 0.860 $29.880 2.600 $29.228 $12.044 14.500 $16.7 .1200 0.800 $ 181.320 2.607.308 Set by management Answers and Solutions: 14 .720 $ 320.279.452 7.500 14.480 0.280 18.490 $33.217 $ 112.160 $ 4.242 7.500 12.000 $ 87.452 10.128 $19.600.000 3.0300 6.880 3.508 3.490 $33.692 20.242 $ 1.166* *From income statement.312 2.500 14. Pro Forma Income Statement December 31. 2005 (Thousands of Dollars) Forecast Basis % 2004 2005 Sales Additions $ 1.380 3.300 3.008 3.000 120.026 $33. & b.13 × Debt04 Additions 2005 $3.960. 14-7 a.968 3.350 10.100 $10.280 $ 332.500 $12.000 $ 73.128 1.3500 0.000 0.811 $ 199.044 14.500 $13.280 $ 302.200 Forecast Basis 1.0800 Pro Forma after Pro Forma Financing Financing $ 1.028 132.10 × Sales04 0. assets Fixed assets Total assets Accounts payable Accruals Notes payable Total current liabilities Long-term debt Total debt Common stock Retained earnings Total liabilities and equity AFN = +2.312 4.534 $ 4.534 Cash Accts receivable Inventories Total curr.100 $ 9.200 $ 108.968 3.December 31.217 Sales Operating costs EBIT Interest EBT Taxes (40%) Net income Dividends: Addition to RE: $ 352.0800 0.160 0.534 $ 4.350 $19. Garlington Technologies Inc. 2005 2004 $3.406 $ 2.800 3.2005 $16.

000 1.000 $1.000 $2.000 Common stock 1.000 Total current liabilities $ 696.783 $ 128.000 Total liab.8 .386.783 198.217 $2.000 AFN = Cumulative AFN = *See income statement.Garlington Technologies Inc.000 720.000 Accruals 180.000 Additions 2005 $ 198.260.000 1.800.700.000 396.000 $ 396.217 87.000 $1.584.217 $2.40 0.440.000 360.783 1.05 AFN Effects With AFN 2005 $ 198.800.000 $ 750.841.783 198.217* Answers and Solutions: 14 .000 $ 128. Pro Forma Balance Statement December 31.10 0.000 792.10 0.000 Retained earnings 204.970.000 Accounts payable $ 360.000 396.386.000 Notes payable 156. 2005 Forecast Basis % 2005 Sales 0.970.05 0.000 1.000 $ 878.000 291.584. and equity $2.800.000 $2.000 792.000 +128.000 $1.000 156.000 $2.700.000 1.783 2004 Cash Receivables Inventories Total current assets Fixed assets Total assets $ 180.20 0.000 291.000 284.970. $ 396.

750.500** Pro Forma $1.500 x 0.200. R/E) Total assets Current liabilities Long-term debt Total debt Common stock Retained earnings Total common equity Total liabilities and equity AFN = Long-term debt = 2004 $1. using the percentage of sales method: Forecast Basis % 2005 Sales 0. Total liabilitie s Accounts Long . b.200.term Common Retained = + + + .$112.000 $ 375.(L*/S)(∆S) .000 75.000 + $105.500 .750 105.25)($2.125.Payout) = $187.Retained earnings and equity = $1.500.000) .000 $ 573.000 = $480.500 $ 907.$295. AFN = (A*/S)(∆S) . 2002 Sales = (1.9 .$75.000 = $300. Alternatively.000 = 48%.(0.750 500.000 = $480.481.000* 112.250 $ 18.500.000 x 1.MS1(1 .06)($3.500 $1.000 $ 480.000 407.25 x 0.000 .500.000 $ 720.000 = $18. Addition to RE = NI x (1 .500. Total debt = Accounts payable + Long-term debt = $375.750 *Given in problem that firm will sell new common stock = $75.500.000 .000.200.000 $1.000 . Payout = 40%.d) . and equity Payable debt stock earnings $1.000 = 15%.000)(0.New common stock = (0. L*/Sales = $375.6) .000/$2. Assets/Sales (A*/S) = $1.200. NI2005 = $2.(0.000 + $295.000.Common stock .000 + Long-term debt + $425. **PM = 6%.000) .000 $ 468.200.15)($625.000) = $3.500.500.14-8 a.750 . Answers and Solutions: 14 .000.000.48 0. Alternatively.48)($625.$75.000 Long-term debt = $105.6 = $112.$425.000.06 = $187.000 295.15 Additions (New Financing. Total Total debt = liabilitie s .000 105.125.000/$2.000 = $375.000 425.$93.

Since the firm currently has $500 of fixed assets.00 × × × + 2 2 2 0.500.00 $1. Addition to RE = M(S1)(1 .000.00 100.00 400.00 × 2 = 150.000.25($2.00 $1.00 $ 50.00 50.Payout ratio) = 0.00 400.00 $1.0 = = = = $ 200.00 290. Answers and Solutions: 14 .00 400.00 + 360.000)(0.10 . Target FA/S ratio = $500/$2.4) = $40.00 500.00 500.00 150.00 200.000) = $500 = Required FA.00 100.000 = 0.00 $ 100.25. Target FA = 0.00 $1.00 250.5 = $1.000.000/0.5 = $2.00 = × 2 = + 40 = Capacity sales = Sales/0.14-9 Cash Accounts receivable Inventories Net fixed assets Total assets Accounts payable Notes payable Accruals Long-term debt Common stock Retained earnings Total liabilities and equity AFN $ 100.00 200.05($2.00 510.00 100.00 400.140. no new fixed assets will be required.00 $ 360.

com. http://brigham.swcollege. Answers and Solutions: 14 .xls) and on the instructor’s side of the web site.11 .SOLUTION TO SPREADSHEET PROBLEM 14-10 The detailed solution for the spreadsheet problem is available both on the instructor’s resource CD-ROM (in the file Solution to FM11 Ch 14 -10 Build a Model.

200. The 2004 financial statements.000.60 $ 32. SEC’s 2004 sales were $2 billion. and the marketing department is forecasting a 25 percent increase for 2005. General. and your first major task is to help her develop the forecast.00 10.00 36. Simmons thinks the company was operating at full capacity in 2004. plus some other data. And Administrative Costs Earnings Before Interest And Taxes Interest Earnings Before Taxes Taxes (40%) Net Income Dividends (40%) Addition To Retained Earnings $2. a Georgia producer of specialized chemicals for use in fruit orchards. but she is not sure about this.00 $ 100. Financial Statements And Other Data On SEC (Millions Of Dollars) A.00 700.00 $ 90. 2004 Income Statement Sales Cost Of Goods Sold (COGS) Sales. are shown below. 2004 Balance Sheet Cash & Securities Accounts Receivable Inventory Total Current Assets Net Fixed Assets Total Assets B. Assume that you were recently hired as Simmons’ assistant.000 5% Mini Case: 14 .00 $ 54. must prepare a financial forecast for 2005.000 % of sales 1% 12 12 25 % of sales Accounts Payable And Accruals Notes Payable Total Current Liabilities Long-Term Debt Common Stock Retained Earnings Total Liabilities And Equity % of sales 60% 35 $ 100 100 $ 200 100 500 200 $1.00 1.00 $ 21. She asked you to begin by answering the following set of questions.40 $ 20 240 240 $ 500 500 $1.12 .MINI CASE Betty Simmons. the new financial manager of Southeast Chemicals (SEC).

Sec 2. Key Ratios Profit Margin Return On Equity Days Sales Outstanding (365 Days) Inventory Turnover Fixed Assets Turnover Debt/Assets Times Interest Earned Current Ratio Return On Invested Capital (NOPAT/Operating Capital) a.(L*/S0)∆S .50 6. (3) that accounts payable and accruals will also grow in proportion to sales.00% 10. (2) that all assets must grow proportionally with sales. Answer: (1) forecast sales.000)(1.67% Industry 4. and (4) that the 2004 profit margin and dividend payout will be maintained. Here is the AFN equation: AFN = (A*/S0)∆S .$25 .40× 3. Answer: SEC will need $184.00× 5.00 Days 11.(L*/S0)(g)(S0) .00 15.000) . (5) decide how to raise funds.M(S0)(1 + g)(1 .5 = $184.5 million. Mini Case: 14 .13 .60 32.33× 4. Answer: Three important uses: (1) forecast the amount of external financing that will be required.M(S1)(RR) = (A*/S0)(g)(S0) .80 Days 8.00 14. (4) project outside funds needed.70 7. (3) project internally generated funds. what will the company’s financial requirements be for the coming year? Use the AFN equation to answer this question. c.25)($2. (2) evaluate the impact that changes in the operating plan have on the value of the firm.$40.000)(0.00 36.5 million.0.payout) = ($1.000/$2. and (6) see effects of plan on ratios and stock price. Under these conditions.00% Describe three ways that pro forma statements are used in financial planning.0270($2.25)(0.6) = $250 .00 30.71 43.000)(0. Explain the steps in financial forecasting. Assume (1) that SEC was operating at full capacity in 2004 with respect to all assets.25)($2.($100/$2.00% 9.C. (3) set appropriate targets for compensation plans b.000) . (2) project the assets needed to support sales.00× 2.

(3) the profit margin increases. and this will reduce the amount of AFN. the higher the capital intensity ratio. 2.” and it is the maximum growth rate which can be financed without outside funds. then both total and retained earnings will increase.) Answer: 1. we can estimate the required assets to support sales and the specified sources of financing. 4. Thus. Mini Case: 14 . If AFN is positive. Put another way. accounts payable. so if the growth rate were zero. Note that if the firm is profitable and has any payout ratio less than 100 percent. leading to a higher AFN. If SEC begins paying sooner. it represents the dollars of assets required per dollar of sales. Given the previous assumptions and choices. the firm would have surplus funds. then you must secure additional financing. more assets are required. (Consider each item separately and hold all other things constant. or AFN. such as costs. accounts receivable. The capital intensity ratio is defined as the ratio of required assets to total sales. AFN would be negative. (2) the dividend payout ratio increases. common stock. As the growth rate rose above zero. which increases the AFN. and this would reduce the need for external financing. If the profit margin goes up. i.e.14 . the greater the AFN. then more earnings would be retained. How would changes in these items affect the AFN? (1) sales increase. dividend policy (which determines retained earnings).e.. other things held constant. it will have some retained earnings. Forecast some items as a percent of the forecasted sales. At some point. at some growth rate.d. or buy short-term investments. buy back stock. the more new money will be required to support an additional dollar of sales. cash. then you have more financing than is needed and you can pay off debt.. inventories. If the payout ratio were reduced. e. Be sure to explain how to forecast interest expenses. net fixed assets. (4) the capital intensity ratio increases. the surplus AFN would be exactly used up. Choose other items according to the company’s financial policy: debt. and accruals. 3. The additional funds needed (AFN) is: required assets minus specified sources of financing. This growth rate where AFN = $0 is called the “sustainable growth rate. 5. The higher the capital intensity ratio. or a*/s0. Answer: Project sales based on forecasted growth rate in sales. i. these surplus funds would be used to finance growth. Briefly explain how to forecast financial statements using the percent of sales approach. this reduces spontaneous liabilities. holding the debt ratio and other ratios constant. and (5) SEC begins paying its suppliers sooner. If AFN is negative. If sales increase.

etc.15 . Basing interest expense on debt at end of year will over-estimate interest expense if debt is added throughout the year instead of all on January 1. or (3) average of beginning and ending debt. Basing interest expense on average of beginning and ending debt will accurately estimate the interest payments if debt is added smoothly throughout the year. There are three ways to approximate interest expense. Mini Case: 14 . You can base it on: (1) debt at end of year. But it doesn’t cause problem of circularity. which reduces retained earnings. but use a slightly higher interest rate. This is easy to implement and is reasonably accurate.Interest expense is actually based on the daily balance of debt during the year. (2) debt at beginning of year. which causes more debt. A solution that balances accuracy and complexity is to base interest expense on beginning debt. which reduces net income. But it has the problem of circularity. It also causes circularity called financial feedback: more debt causes more interest. See FM11 Ch 14 Mini Case Feedback. Basing interest expense on debt at beginning of year will under-estimate interest expense if debt is added throughout the year instead of all on December 31.xls for an example basing interest expense on average debt.

0 $ 21.0 $ 54. Answer: See the completed worksheet.0 $ 63.8 Mini Case: 14 .0 $ 42.f.6 $ 32.00% $ 700. will be the same percent of sales in 2005 as in 2004. and (5) interest expenses should be based on the balance of debt at the beginning of the year.0 $ 10. (3) that external funds needed are financed 50 percent by notes payable and 50 percent by long-term debt (no new common stock will be issued).” but we used a spreadsheet model for the flexibility such a model provides.0 Growth 1.2 $ 37.25 $ 1. accruals. Income Statement (In Millions Of Dollars) Sales COGS SGA Expenses EBIT Less Interest EBT Taxes (40%) Net Income Dividends Add.0 $ 20. Assume (1) that each type of asset.0 $ 125.200.500.00% $ 100. To Retained Earnings Actual 2004 Forecast Basis $ 2. (4) that all debt carries an interest rate of 10 percent. Now estimate the 2005 financial requirements using the percent of sales approach.0 % Of Sales 60.0 $ 875.16 .0 % Of Sales 35.0 $ 1. and fixed and variable costs.0 $ 105.000.0 Interest Rate X Debt04 $ 90. as well as payables.4 Forecast 2005 $ 2. (2) that the payout ratio is held constant at 40 percent. The problem is not difficult to do “by hand.0 $ 25.500.0 $ 36.

0 $1.00% $300.00% $625.0 % Of Sales 12.0 $100.0 $300.0 $93.0 % Of Sales 5.8 $1.0 $100.0 $300.6 $325.0 % Of Sales 1.0 $625.0 $1.0 % Of Sales 25.0 $100.8 $1.0 $200.0 $500.0 $93.0 RE04 + $200.0 % Of Sales 12.0 $240.0 Mini Case: 14 .0 $500.0 $737.000.0 $237.0 Carry-Over $100.0 $1.6 $225.8 $700.17 .000.250.6 $318.00% $125.0 Carry-Over $500.2 $500.8 $187.0 $625.0 $500.062.6 $193.250.Balance Sheet (In Millions Of Dollars) 2004 Assets Cash Accounts Receivable Inventories Total Current Assets Net Plant And Equipment Total Assets Liabilities And Equity Accounts Payable & Accruals Notes Payable Total Current Liabilities Long-Term Bonds Total Liabilities Common Stock Retained Earnings Total Common Equity Total Liabilities And Equity Required Assets = Specified Sources Of Financing = Additional Funds Needed (AFN) $ 20.0 $300.0 Forecast Basis 2005 Forecast Without AFN AFN 2005 Forecast With AFN 0 $ 25.00% $ 25.0 $193.0 $1.8 $1.0 $625.250.250.0 $1.0 $240.0 ∆RE04 $237.20 $125.8 $737.0 Carry-Over $100.00% $300.062.6 $512.

18 . but in this case the difference is not very large. Mini Case: 14 . The real advantage of the balance sheet method is that it can be used when everything does not increase proportionately with sales. and the balance sheet method is necessary to develop the ratios. Why does the percent of sales approach produce a somewhat different AFN than the equation approach? Which method provides the more accurate forecast? Answer: The difference occurs because the AFN equation method assumes that the profit margin remains constant. In practice. The balance sheet method is somewhat more accurate. while the forecasted balance sheet method permits the profit margin to vary. forecasters generally want to see the resulting ratios. the only time we have ever seen the AFN equation used is to provide (1) a “quick and dirty” forecast prior to developing the balance sheet forecast and (2) a rough check on the balance sheet forecast.g. In addition.

54% 15.4) + [($625 .Operating Capital2004) = $125(1 . Mini Case: 14 .80 43.00% TIE 10.00 6. Actual Forecast 2004 2005 Industry Answer: Key Ratios Profit Margin 2.80 32. = Note: Operating Capital = Net Operating Working Capital + Net Fixed Assets.067 = 6. and compare them with the company's 2004 ratios and with the industry averages.60% DSO 43. Calculate SEC's forecasted ratios.33 8.00% ROE 7.00 Free Cash Flow Operating Gross Investment in Cash Flow Operating Capital = NOPAT .00 Inventory Turnover 8.($500 .52% 4.00 Debt/Assets 30.19 .25 9.50 1.$225 = -$150.70% 2.$100 + $500) = $75 .($1.71% 8.00% 40. ROIC = NOPAT / Capital = $75 / $1.Net Investment In Operating Capital FCF = NOPAT .40 Current Ratio 2.00 Fixed Asset Turnover 4.0.$900) = $75 .98% 36.00 4.33 11.h.125 = 0.67%.$125 + $625) .00 5.(Operating Capital2005 .96 3. Calculate SEC’s forecasted free cash flow and return on invested capital (ROIC).125 .

the funds needed will decline by $125.20 12. 1. does it appear that SEC is operating efficiently with respect to its inventory and accounts receivable? Suppose SEC was able to bring these ratios into line with the industry averages and reduce its SGA/sales ratio to 33%. but that excess capacity existed with regard to fixed assets.0% 35. Therefore. it will not have to add as much fixed assets during 2005 as was originally forecasted: j.8% 12. How would the existence of excess capacity in fixed assets affect the additional funds needed during 2005? Answer: We had previously found an AFN of $184. 0.5 using the balance sheet method.33 12.5 10.i.0% $187. Before 43.0% 8. What effect would this have on its AFN and its financial ratios? What effect would this have on free cash flow and ROIC? Answer: The DSO and inventory turnover ratio indicate that SEC has excessive inventories and receivables. Specifically.3% Suppose you now learn that SEC’s 2004 receivables and inventories were in line with required levels.xls. Based on comparisons between SEC's days sales outstanding (DSO) and inventory turnover ratios with the industry average figures.000 Answer: Full Capacity Sales = % of capacity at which = = $2. What level of sales could have existed in 2004 with the available fixed assets? j. fixed assets were operated at only 75 percent of capacity. Actual sales $2. 2. Mini Case: 14 .77% 11.25($500) = $125.2 -$150.00 9.75 fixed assets were operated Since the firm started with excess fixed asset capacity. Inputs DSO Accounts Receivable/Sales Inventory Turnover Inventory/Sales SGA/Sales Outputs AFN FCF ROIC ROE j. given the firm’s credit and inventory policies.0 6. See the results below based on the spreadsheet FM11 Ch 14 Mini Case.09% 33.667.0% $15.7% 8.01 8. The fixed assets increase was 0. The effect of improvements here would reduce asset requirements and AFN.20 .7 $33.5% After 32.

Explain how each of the following factors would affect the accuracy of financial forecasts based on the AFN equation: (1) economies of scale in the use of assets. Cash and inventory are common examples.k. The percent of sales approach. under the assumption that each asset item grows at the same rate as sales. hence it will grow less rapidly than sales. and (2) lumpy assets. leads to an AFN forecast that is reasonably close to the forecast using the AFN equation. with possible relationship to sales as shown below: Inventories Cash 0 0 Sales Sales Inventories Base Stock 0 Sales Mini Case: 14 .21 . Economies of scale in the use of assets mean that the asset item in question must increase less than proportionately with sales. The relationship between sales and the various types of assets is important in financial forecasting. Answer: 1.

22 . Lumpy assets would cause the relationship between assets and sales to look as shown below. Fixed assets 0 Sales Mini Case: 14 . This situation is common with fixed assets.2.