Preparatory Question Set

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1 Preparatory Question Set: Financial Forecasting (Module III) 1. Answer the following questions regarding financial forecasting: a. Which items comprise operating current assets? Why is it reasonable to assume that they grow proportionally to sales or COGS? Which ones are proportional to sales and which ones are proportional to COGS? Explain b. What are some reasons that net PP&E might grow proportionally to sales, and what are some reasons that it might not? c. What are spontaneous liabilities and why is it reasonable to assume they grow at proportion of sales or COGS? What are spontaneous liabilities also known as (in fact, we used this alternate name in previous modules)? What are the most common examples of spontaneous liabilities? 2. Answer the following questions regarding financial forecasting: a. How are operating items projected on financial statements? b. How are preliminary levels of debt, preferred stock, common stock, and dividends projected? c. Suppose COGS is currently 67% of sales and over the next year sales growth by 5% and growth COGS is 3%. Do you predict the COGS as a percent of sales will increase, increase, or remain the same over the next year? Explain and verify your intuition by calculating the COGS be as a percent of sales at year-end? d. What is the financing surplus or deficit in general? How is it calculated? 3. Define the following terms related to financial forecasting? a. Operating plan; financing plan b. Spontaneous liabilities; profit margin; payout ratio c. Additional funds needed (AFN); capital intensity ratio; self-supporting growth rate d. Forecasted financial statement approach using percentage of sales e. Excess capacity; lumpy assets; economies of scale f. Full capacity sales; target fixed assets to sales ratio; required level of fixed assets 4. The following questions relate to the process of financial forecasting a. Generally the maximum time horizon over which we forecast pro forma statements is till one year after a firm matures. What are the characteristics of a firm when it matures? b. Discuss a firm’s operating plan and financing plan as it relates to financial forecasting. c. Describe the process (through at least 3 passes) through which you can forecast next year’s statements? Why are multiple passes needed? In which passes is the information in operating plan and financing plan incorporated? 5. Answer the following questions related to AFN. a. The following equation is sometimes used to forecast funding requirements: AFN= (A0*/S0)( ∆ S) – (L0*/S0)( ∆ S) – MS1(1- POR) What key assumption do we make when using this equation? Under what conditions might this assumption not hold true? What would be the more general formula for AFN? b. Name five key factors that affect a firm’s external financing requirements. Explain how each one affects the requirements?
2 c. What is meant by the term “self-supporting growth rate”? How is this rate related to the AFN equation, and show how this equation be used to calculate the self-supporting growth rate? d. Suppose a firm makes the following policy changes listed. If a change means that external, nonspontaneous financial requirements (AFN) will increase, indicate this by a (+); indicate a decrease by a (−); and indicate no effect or an indeterminate effect by a (0) and explain your reasoning. Think in terms of the immediate effect on funds requirements. i) The dividend payout ratio is increased. ii) The firm decides to pay all suppliers on delivery rather than after a 30-day delay in order to take advantage of discounts for rapid payment. iii) The firm begins to offer credit to its customers, whereas previously all sales had been on a cash basis. iv) The firm’s profit margin is eroded by increased competition, although sales hold steady. v) The firm sells its manufacturing plants for cash to a contractor and simultaneously signs an outsourcing contract to purchase from that contractor goods that the firm formerly produced. vi) The firm negotiates a new contract with its union that lowers its labor costs without affecting its output. 6. Answer the following three questions: a. Suppose the CFO does not want to raise external capital (debt or equity) under any circumstance (including when the firm has great investment opportunities but needs external capital to fund them all). What are the firm’s options? How much can the firm grow (Self-supporting growth rate) if no capital is raised (AFN must equal 0). b. Is it possible that after the first pass Total Assets > Total Liabilities + Total Equity? If so, under what situation? What do you do in this situation? c. Is it possible for an increase in sales to be accompanied by no increase in fixed assets? If so, under what condition can this occur? Can this be sustained in the long-run? d. How would economies of scale and lumpy assets affect financial forecasting? 7. (End-of-chapter numerical problem 9.1-9.3) Broussard Skateboard’s sales are expected to increase by 15% from $8 million in 2013 to $9.2 million in 2014. Its assets totaled $5 million at the end of 2013. Broussard is already at full capacity, so its assets must grow at the same rate as projected sales. At the end of 2013, current liabilities were $1.4 million, consisting of $450,000 of accounts payable, $500,000 of notes payable, and $450,000 of accruals. The after-tax profit margin is forecasted to be 6%, and the forecasted payout ratio is 40%. Answer the following questions. a. Use the AFN equation to forecast Broussard’s additional funds needed for the coming year. b. What would be the additional funds needed if the company’s year-end 2013 assets had been $7 million? Assume that all other numbers, including sales, remain the same. Why is the AFN different in this scenario? Is the company’s “capital intensity” ratio the same or different? c. Return to the assumption that the company had $5 million in assets at the end of 2013, but now assume that the company pays no dividends. Under these assumptions, what would be the additional funds needed for the coming year? Why is this AFN different from the one you found in part a? 8. (Instructor Problem – no solutions) The Henley Corporation is a privately held company specializing in lawn care products and services. You are given data for the most recent fiscal year, 2007.
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