Module 3- Financial Planning and Growth – Financial Management
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3.5 | Exercises.
Problem: Short-term Financial Planning
Sales
Wind’n Wave Enterprises is a wholesaler of wind surfers,
which currently sells one model, the Wave Rider (WR). The
product is sold locally through major sports stores. The com-
pany has also begun to export, which helps to smooth out
seasonal fluctuations in production and sales. At present, the
business has three local customers and one overseas.
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Wind’n Wave 2018 Sales Forecast (Units)
Q1
Q2
Q3
Q4
Year
Local
Customer 1
43
76
58
27
204
Customer 2
56
122
87
22
287
Customer 3
33
66
48
17
164
Sub-total
132
264
193
66
655
Export
77
114
115
77
383
Total
209
378
308
143
1,038
Expected prices for 2018 for Wave Rider are:
Price (CAD Per Unit)
Local
Export
Wave Rider (WR)
900
675
Twenty percent of sales are for cash. Of the credit sales, ap-
proximately 70.0% are paid for in the quarter the sale takes
place and the balance are collected in the following quarter
with negligible bad debts.
Sales in the first quarter of 2019 are expected to be 250 units,
which is 20.0% higher than the first quarter of 2018.
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Cost of Goods Sold
Wind’n Wave gets its product from a system of small indepen-
dent contractors. In the coming year, the company expects
to be able to buy Wave Riders for CAD 525.
Seventy percent of all merchandise purchased is paid for in
that quarter.
The remainder is paid for in the following quar-
ter.
Company policy is to maintain merchandise inventory in units
equal to 30.0% of the next quarter’s estimated sales in units.
This is to guard against supply interruptions, which are fre-
quent given the size of its suppliers. Beginning inventory on
January 1, 2018 consists of 63 units.
Operating Expenses
Wind’n Waves financial manager has put together the follow-
ing information on estimated operating expenses for 2018
:
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Category
Details
Selling
Fixed component of CAD 35,500 a year plus a
variable component equal to 1.0% of sales revenue
for sales commissions.
Distribution
All variable equal to CAD 7 per unit for local sales
and CAD 15 per unit for exports.
Administrative
All fixed equal to CAD 45,200 a year including
CAD 7,000 for depreciation of fixed assets and
CAD 18,000 in rent.
All fixed costs are incurred uniformly throughout the year and
are paid for as incurred.
Capital Budget
Wind’n Wave’s financial manager has reviewed an updated list
of capital expenditures in 2018 and has selected the following
projects:
Item
Estimated
Cost
When
New computer with associated software for
bookkeeping, scheduling, and word
processing – 5-year life
CAD
26,000
End
Q1
New office equipment – 10-year life
CAD
19,500
End
Q2
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Depreciation charges for these assets were not included in
the administration budget.
Financing
Wind’n Wave has an 8.0% line of credit, which allows it to
borrow up to CAD 40,000 to finance its accounts receivable
and inventories. The bank allows Wind’n Wave to borrow up
to 50.0% of the value of their good accounts receivable but
nothing against their finished goods inventory due to its
highly specialize nature. Interest is paid quarterly and any
borrowing or paying down of the loan is be done at the end of
each quarter. The line of credit must be paid down to zero
once per year.
The company’s purchases of capital assets can be financed
with a term loan. Interest is paid quarterly at a rate of 10.0%.
The principal is paid down on a straight-line basis over the
life of the asset. Payments are made quarterly. Up to 80.0%
of the asset’s value can be borrowed.
Company policy is to try to maintain a cash balance of CAD
20,000 at all times to guard against unexpected cash out-
flows. This approximates 10.0% of quarterly cash disburse-
ments. Surplus cash can be invested in 3-month term de-
posits earning 5.0%. Interest is paid quarterly.
Quarterly and annual financial statements must be submitted
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to the bank. In addition to the required coverage ratio, the
bank requires that a current ratio of at least 1.5X be main-
tained on a quarterly basis. Also, an annual cash flow cover-
age ratio of at least 2.0 must be maintained.
The goal for the long-term debt to total capitalization ratio is
40.0%. Company policy is to match the maturity of its assets
and financing if possible.
Dividends
Regular dividends of CAD 15,000 are to be paid out each quar-
ter unless a serious cash shortage prevents it. Special divi-
dends can be paid if the company’s cash balance becomes ex-
cessive.
Income Taxes
The corporate tax rate is 45.0%. Taxes are paid at the end of
each quarter.
Balance Sheet
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Wind’n Wave
Balance Sheet
December 31, 2017
Current assets
Cash
CAD 21,483
Accounts receivable
26,700
Inventory
32,918
Total current assets
CAD 81,101
Fixed assets
Equipment
91,788
Total assets
CAD 172,889
Current liabilities
Line of credit
–
Accounts payable
CAD 27,563
Current portion of long-term debt
10,000
Total current liabilities
CAD 37,563
Long-term liabilities
Term loan
50,000
Shareholders’ equity
Share capital
53,000
Retained earnings
32,326
Total liabilities and equity
CAD 172,889
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REQUIRED:
1. Prepare budgeted income statements, cash flow state-
ments, balance sheets, and key financial ratios for Q1
2018.
2. Why did the company experience a cash shortage in
Q1?
3. What actions could be taken to increase cash flows in
Q1?
4. What actions could be taken to increase the current
ratio in Q1?
5. What actions could be taken to reduce the long-term
debt to total capitalization ratio in Q1?
6. How was the CAD 35,000 limit on the line of credit de-
termined?
7. How was the desired cash level of CAD 20,000 deter-
mined?
8. Prepare pro forma financial statements and key finan-
cial ratios for Q2, Q3, and Q4 2018.
9. Analyze the financial decisions made in Q1, Q2, Q3, and
Q4 2018 focusing on the interrelationships between
each of the quarters.
Problem: Percen
t
age of Sales Method
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The following are the financial statements of Quick Silver Ltd.
for the previous year.
2013
Net sales
CAD 4,377,432
Expenses
Cost of sales
CAD 3,185,784
Marketing and sales
496,786
Administration and research
285,475
Interest
34,563
Depreciation
126,777
Earnings before taxes
CAD 248,047
Income taxes
74,414
Net income
CAD 173,633
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2013
Current assets
Cash
CAD 34,756
Temporary investments
305,815
Accounts receivables
550,345
Inventories
394,356
Prepaid expenses
30,345
Total current assets
CAD 1,315,617
Property, plant, equipment
1,320,334
Other assets
257,654
Total assets
CAD 2,893,605
Current liabilities
Accounts payable
532,902
Accrued payroll payables
243,826
Income taxes payable
6,201
Total current liabilities
CAD 782,929
Long-term liabilities
597,853
Shareholders’ equity
1,512,824
Total liabilities and equity
CAD 2,893,605
Quick Silver estimates that sales will increase by 5.0% over
each of the next three years. The company has a target long-
term debt to total capitalization ratio of 30.0% which is 10.0%
below the industry average. Quicksilver founder and CEO
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had difficulties with excessive debt early on in the company’s
life and has compensated by borrowing less. Dividends are
currently CAD 80,000 per year and company policy is to in-
crease dividends only if they can be maintained. The compa-
ny also refuses to lower dividends as it will cause excessive
market pessimism leading to a lower share price. The is-
suance of new equity is avoided for reasons of control.
REQUIRED:
1. Prepare proforma income statements, cash flow state-
ments, and balance sheets for the next three years. Can
the company meet its goal of 5.0% growth over the next
three years without reducing the regular dividend or
issuing new common shares?
2. Could a 20.0% growth rate over the next three years be
supported? Discuss.
Problem: Adjusting Asset Requirements for Excess
Capacity
Meta Industries’ sales were CAD 150 million in the current
year but are expected to increase by 10.0% next year. The
company’s fixed assets are currently underutilized and could
support sales of approximately CAD 170 million. Capacity can
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be added in increments of CAD 20 million in sales at a cost of
CAD 8 million.
REQUIRED:
1. What is Meta’s capacity utilization?
2. How much additional fixed assets will be required next
year?
3. How would the answer to Part 2 change if sales were
expected to increase by 20.0% next year?
Problem: Analyzing Sus
t
ainable Growth at Wicker
Company
The following are selected financial data for Wicker Company,
a patio furniture manufacturer:
2011
2012
2013
2014
2015
Retention ratio
1.00
0.90
0.85
0.74
0.65
Net profit margin (%)
7.90
8.10
8.10
8.20
8.40
Asset turnover
1.34
1.22
1.17
1.14
1.07
Assets/equity
2.49
2.15
1.81
1.61
1.31
Actual growth rate (%)
5.67
8.95
10.10
9.45
8.73
REQUIRED:
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1. Calculate the sustainable growth rate for 2011 through
2015.
2. Analyze the differences between the actual and sustain-
able growth rates.
Discussion
Problem: Analyzing Sus
t
ainable Growth at Telsa
Fashions
The following are selected financial data for Telsa Fashions, a
women’s clothing retail chain with extensive e-commerce op-
erations:
2011
2012
2013
2014
2015
Retention ratio
1.00
1.00
1.00
1.00
1.00
Profit margin (%)
0.45
0.52
2.85
3.72
3.81
Asset turnover
2.24
2.41
2.48
2.51
2.53
Assets/equity
1.85
1.85
2.01
2.19
2.39
Actual growth rate (%)
8.9
10.3
18.9
28.9
29.85
REQUIRED:
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1. Calculate the sustainable growth rate for 2011 through
2015.
2. Analyze the differences between the actual and sustain-
able growth rates.
Problem: Analyzing Sus
t
ainable Growth at Caribou
Manu
f
acturing
Wilma Cartlidge is the sole owner of Caribou Manufacturing
in Kamloops, British Columbia. The company began opera-
tions in early 2011 and has experienced rapid growth.
2011
2012
2013
2014
2015
Retention ratio
1.00
0.85
0.75
0.65
0.60
Net profit margin (%)
3.50
4.50
5.20
5.50
5.00
Asset turnover ratio
1.35
1.43
1.51
1.59
1.61
Debt ratio (%)
25.21
31.25
34.78
44.45
55.01
ROE (%)
6.32
9.36
12.04
15.74
17.89
Sustainable growth rate (%)
6.74
8.64
9.93
11.40
12.03
Actual growth rate (%)
6.32
8.45
9.79
11.43
12.25
Cartlidge is very proud of her success and her ability to man-
age the company’s growth without having to raise new equity
or refuse new business. Many of her colleagues told her that
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periods of rapid growth were some of the most challenging
for small businesses.
Cartlidge is preparing to meet with her banker to discuss a
new loan application for 2016. Last year, the banker showed
considerable hesitation about approving any new loans but
she still managed to convince him to approve her application.
REQUIRED:
1. Analyze Caribou’s growth over the last five years and
make recommendations for change.
Problem: Analyzing Sus
t
ainable Growth at Beluga
Manu
f
acturing
Jurgen Vincenten owns Beluga Manufacturing Ltd. in
Churchill, Manitoba, which has been in existence for five
years.
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2015
2016
2017
2018
2019
Industry
Average
Retention ratio
1.00
0.83
0.74
0.62
0.48
0.65
Net profit margin
(%)
3.62
4.29
4.56
4.41
4.38
6.31
Asset turnover ratio
1.39
1.51
1.53
1.48
1.47
1.69
Debt ratio (%)
20.33
33.78
39.67
47.38
59.23
35.22
ROE (%)
6.32
9.78
11.56
12.40
15.79
16.46
Sustainable growth
rate (%)
6.74
8.84
9.36
8.33
8.20
11.98
Actual growth rate
(%)
6.70
8.73
9.32
8.43
8.32
12.01
Beluga grew over this period but had to slow its growth in
recent years by refusing sales from new customers because of
insufficient financing from its bank. Vincenten felt his growth
rate could have exceeded the industry average if financing
was available. Raising new equity capital by bringing in new
owners is not an option for Vincenten as he feels he does not
have the temperament to share control with anyone.
Beluga’s banker requested a meeting in early January 2020 to
discuss Beluga’s loans and the overall condition of the busi-
ness. Last year the banker was very concerned about Beluga’s
financial position, but Vincenten felt he would be satisfied
this year given Beluga’s continue growth.
Vincenten has just completed the construction of a new home
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LICENSE
Financial Management Copyright
© by Dan Thompson is licensed
under a Creative Commons
Attribution 4.0 International
License
, except where otherwise
noted.
SHARE THIS BOOK
overlooking the Hudson’s Bay in Churchill.
REQUIRED:
1. Analyze Beluga’s growth over the last five years and
make recommendations for change.
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- Financial Accounting question.arrow_forwardComputing breakeven sales and sales needed to earn a target profit; graphing CVP relationships; performing sensitivity analysis National Investor Group is opening an office in Portland, Oregon. Fixed monthly costs are office rent ($8,100), depreciation on office furniture ($1,700), utilities ($2,000), special telephone lines ($1,500), a connection with an online brokerage service ($2,500), and the salary of a financial planner ($5,200). Variable costs include payments to the financial planner (9% of revenue), advertising (11% of revenue), supplies and postage (4% of revenue), and usage fees for the telephone lines and computerized brokerage service (6% of revenue). Requirements Use the contribution margin ratio approach to compute Nationals breakeven revenue in dollars. If the average trade leads to $1,000 in revenue for National, how many trades must be made to break even? Use the equation approach to compute the dollar revenues needed to earn a monthly target profit of $12,600.…arrow_forwardQ1. Below is the projected financial information provided by Altaf Hussain Manufacturing LLC. The company wants to introduce two new products into the market, Zandu and Eundu. The company provides the following forecasted information of sales and costs. Sales in units Product/Year Year 1 Year 2 Year 3 Year 4 Zandu 60,000 110,000 100,000 30,000 Eundu 75,000 137,000 125,000 37,500 Product Zandu Eundu Direct material costs 14 11 Selling price 31 23 Selling price inflation (per year). 3% Direct material cost inflation (per year) 3% Advertisement cost (First Year) 500,000 Advertisement cost (2nd and 3rd Year) 200,000 Investment 1,000,000 Machinery 1,000,000 Fixed costs 1,000,000 Таx 25% Residual value 1.2million Required: Calculate NPV and IRR of this proposal project using MS Excel. Hint: Calculate expected revenue 2. Expected costs 3. Expected cashflows 1. to calculate NPV and IRR MTEESarrow_forward
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ISBN:9781337690881
Author:Jay Rich, Jeff Jones
Publisher:Cengage Learning