978-1337614689 Chapter 10 Part 2

10–14

2012 $160,814,329 440,587 14 $6,168,221

4. The following information about Douglas Corp.’s Accounts Receivable and Sales are presented below:

Year 2012-Beginning Balance of A/R = $791M

Year 2012 -Ending Balance of A/R = $807M

Year 2012 – Sales = $3,002M

Assumptions:

Sales growth will be equal to 6% per year

A/R turnover will stay constant throughout the forecast period

Required:

a. Using this information, forecast Douglas Corp.’s the growth in Accounts Receivable for years

2013-2017.

b. What problem does a constant A/R turnover assumption cause?

c. Provide a solution to the problem caused by a constant A/R turnover assumption.

ANS:

a.

2012 2013* 2014* 2015* 2016* 2017*

c.

2012 2013* 2014* 2015* 2016* 2017*

5. The following balance sheet and income statement pertain to Goode Corp., using the following

assumptions complete a forecasted 2013 income statement:

Assumptions for 2013:

Revenue growth rate 45%

COGS 70% of sales

Operating expenses 18% of sales

Interest expense 12% of beginning long-term debt

Tax rate 35%

Goode Corp. Consolidated Statement of Income

(Thousands except per share amounts) 2012

Net Revenues $345,871

Cost of Revenue (226,546)

SG&A (83,009)

Operating Income 36,316

Interest Expense (484)

Income Before Income Taxes 35,832

Income taxes (12,541)

Net Income $23,291

Goode Corp Consolidated Balance Sheet

(Thousands) 2012

Current Assets

Cash and Equivalents 7,905

Merchandise inventory 6,308

Accounts receivable 6,614

PPE (including intangibles), net 39,458

Total Assets 60,285

Liabilities and Stockholders’ Equity

Accounts payable 9,643

Long-term debt 13,500

Shareholders’ Equity

Common stock and APIC 28,613

Retained earnings 8,529

Total Liabilities and Shareholders’ Eq. 60,285

10–16

6. Simmons Company

These data represent a summary of your first-iteration forecast amounts for Year 1. Simmons uses

dividends as a flexible financial account.

Year + 1

Operating Income $ 58

Interest Expense 8

Income before Tax $ 50

Tax Provision (20.0 percent effective tax rate) 10

Net Income $ 40

Total Assets $200

Accrued Liabilities $ 43

Long-Term Debt $ 80

Common Stock, at par $ 20

Retained Earnings (at the beginning of Year 1) $ 34

A. See the information for Simmons Company.

Compute the amount of dividends you can assume that Simmons will pay in order to balance your

projected balance sheet. Present the projected balance sheet.

B. See the information for Simmons Company.

Now assume that Simmons pays common shareholders a dividend of $25 in Year +1. Also assume

that Simmons uses long-term debt as a flexible financial account, increasing borrowing when it needs

capital and paying down debt when it generates excess capital. For simplicity, assume that Simmons

pays 10.0 percent interest expense on the ending balance in long-term debt for the year and that

interest expense is tax deductible at Simmons’ average tax rate of 20.0 percent.

Present the projected income statement and balance sheet for Year +1. (Hint: Because of the

circularity between interest expense, net income, and debt, several iterations may be needed to

balance the projected balance sheet and to have the projected balance sheet articulate with net

income. You may find it helpful to program a spreadsheet to work the iterative computations.)

ANS:

A. This problem basically asks students to compute the plug to dividends to balance the balance sheet for

10–17

B. This problem asks students to compute the plug to long-term debt to balance the balance sheet for

Simmons Company for Year +1. This problem introduces circularity to balancing the balance sheet

because the amount of debt needed depends on net income, which is affected by the interest expense

on the amount of debt needed. Students should input these amounts into a spreadsheet and have the

spreadsheet compute the amounts iteratively. Students should obtain the following amounts:

Year +1

Projected Income Statement Amounts

7. Repair Specialists is a leading retailer of home improvement products. It operates large warehouse-style

stores. Despite declining sales and difficult economic conditions in 2009 and 2010, Repair Specialists

continued to invest in new stores. The following table provides summary data for Repair Specialists.

Repair Specialists

(amounts in millions except number of stores) 2009 2010

Number of stores 2,234 2,274

Sales revenues $77,349 $71,288

Inventory $11,731 $10,673

Capital expenditures, net $ 3,558 $ 1,847

10–18

Required

a. Use the preceding data for Repair Specialists to compute average revenues per store,

capital spending per new store, and ending inventory per store in 2010.

b. Assume that Repair Specialists will add 100 new stores by the end of Year 1. Use

the data from 2010 to project Year 1 sales revenues, capital spending, and ending

inventory. Assume that each new store will be open for business for an average of

one–half year in Year 1. For simplicity, assume that in Year 1, Repair Specialists’ sales

revenues will grow, but only because it will open new stores.

ANS:

In this problem, students work through the computations to project revenue, capital expenditures, and

ending inventory for Repair Specialists, using 100 new stores as the driver of growth forecasts in Year +1.

Repair Specialists (Data in Mil– REQ. B

lions Except Number of Stores) 2009 2010 Year +1 Computations

8. Techtronics is a leader in manufacturing computer chips, which is very capital-intensive. Because the

production processes in computer chip manufacturing require sophisticated and rapidly changing

technology, production and manufacturing assets in the chip industry tend to have relatively short useful

lives.

The following summary information relates to Techtronics’ property, plant, and

equipment for 2009 and 2010:

Techtronics (amounts in millions) 2009 2010

Property, Plant, and Equipment, at cost $ 46,052 $ 48,088

Accumulated Depreciation $(29,134) $(30,544)

Property, Plant, and Equipment, net $ 16,918 $ 17,544

Depreciation Expense $ 4,360

Capital Expenditures, net $ 5,200

10–19

Required

Assume that Techtronics depreciates all property, plant, and equipment using the straight-line

depreciation method and zero salvage value. Assume that Intel spends $6,000 on new

depreciable assets in Year 1 and does not sell or retire any property, plant, and equipment

during Year 1.

a. Compute the average useful life that Techtronics used for depreciation in 2010.

b. Project total depreciation expense for Year 1 using the following steps: (i) project

depreciation expense for Year 1 on existing property, plant, and equipment at the

end of 2010; (ii) project depreciation expense on capital expenditures in Year 1

assuming that Intel takes a full year of depreciation in the first year of service; and

(iii) sum the results of (i) and (ii) to obtain total depreciation expense for Year 1.

c. Project the Year 1 ending balance in property, plant, and equipment, both at cost

and net of accumulated depreciation.

ANS:

This problem gets students working through the computations to project property, plant, and equipment

and depreciation expense for Year +1 for Techtronics, a leading manufacturer of computer chips.

Techtronics (Data in Millions) 2009 2010 Year +1 Computations

9. Arco is an integrated manufacturer in capital-intensive industry. Nuwak manufactures more

commodity-level products in the same industry at the lower end of the market and uses less

capital-intensive processes. The following data describe sales and cost of products sold for both firms for

Years 3 and 4.

($ amounts in millions) Year 3 Year 4

Arco

Sales $4,042 $ 5,217

Cost of Products Sold 3,887 4,554

Gross Profit $ 155 $ 663

Gross Margin 3.8% 12.7%

Nuwak

Sales $6,266 $11,377

Cost of Products Sold 5,997 9,129

Gross Profit $ 269 $ 2,248

Gross Margin 4.3% 19.8%

Industry analysts anticipate the following annual changes in sales for the next five years:

Year +1, 5 percent increase; Year +2, 10 percent increase; Year +3, 20 percent increase; Year +4, 10

percent decrease; Year +5, 20 percent decrease.

Required

a. The analyst can sometimes estimate the variable cost as a percentage of sales for a

particular cost (for example, cost of products sold) by dividing the amount of the

change in the cost item between two years by the amount of the change in sales for

those two years. The analyst can then multiply the variable-cost percentage times

sales to estimate the total variable cost. Subtracting the variable cost from the total

cost yields an estimate of the fixed cost for that particular cost item. Follow this procedure

to estimate the manufacturing cost structure (variable cost as a percentage of

sales, total variable costs, and total fixed costs) for cost of products sold for both Arco and Nuwak in

Year 4.

b. Discuss the structure of manufacturing cost (that is, fixed versus variable) for each

firm in light of the manufacturing process and type of product produced.

c. Using the analysts’ forecasts of sales changes, compute the projected sales, cost of

products sold, gross profit, and gross margin (gross profit as a percentage of sales)

of each firm for Year +1 through Year +5.

d. Why do the levels and variability of the gross margin percentages differ for these two

firms for Year +1 through Year +5?

ANS:

10–21

b. Arco is more capital-intensive than Nuwak and therefore has a higher proportion of fixed

c. (Amounts in Millions)

Arco

Nuwak

d. The average gross margin of Arco is 16.7 percent, with a standard deviation of 3.5 percent.

10. Saunders Corporation manufactures consumer electronics products. Selected income statement data for

2009 and 2010 follow (amounts in millions of dollars):

Saunders Corporation (amounts in millions of dollars) 2009 2010

Sales 8,296 8,871

Cost of Goods Sold (5,890) (6,290)

Selling and Administrative Expenses (1,788) (1,714)

Operating Income before Income Taxes 618 867

Required

a. The analyst can sometimes estimate the variable cost as a percentage of sales for a particular cost (for

example, cost of goods sold) by dividing the amount of the change in the cost item between two years by

the amount of the change in sales for those two years. The analyst can then multiply total sales by the

variable-cost percentage to determine the total variable cost. Subtracting the variable cost from the total

cost yields the fixed cost component for that particular cost item. Follow this procedure to determine the

cost structure (fixed cost plus variable cost as a percentage of sales) for cost of goods sold for Saunders.

b. Repeat requirement a. for selling and administrative expenses.

c. Saunders Corporation discloses that it expects sales to grow at the following percentages

in future years: Year 1, 12 percent; Year 2, 10 percent; Year 3, 8 percent; Year 4, 6 percent. Project sales,

cost of goods sold, selling and administrative expenses, and operating income before income taxes for

Saunders for Year 1 to Year 4 using the cost structure amounts derived in requirements a. and b.

d. Compute the ratio of operating income before income taxes to sales for Year 1 through Year 4.

e. Interpret the changes in the ratio computed in requirement d. in light of the expected changes in sales.

ANS:

Identifying the Cost Structure (Amounts in Millions of Dollars)

b. Change in Selling and Administrative Expense: ($1,714 – $1,670) ……. $ 44

10–23

Variable (.696 of Sales) …………… (6,915) (7,607) (8,216) (8,708)

e. The percentage of operating income before income taxes to sales increases over time because

Saunders Corporation spreads its fixed operating costs over a larger sales volume. These

11. Hart designs, manufactures, and markets toys in domestic and international markets. Sales during 2010

totaled $4,022 million. Accounts receivable totaled $655 million at the beginning of 2010 and $612

million at the end of 2010.

Required

a. Use the average balance to compute the accounts receivable turnover ratio for Hart for 2010.

b. Hart generated a compound annual sales growth rate of 13.0 percent over the past two years. Assume

that Hart’s sales will continue to grow at that rate each year for Year +1 through Year +5 and that the

accounts receivable turnover ratio each year will equal the ratio computed in requirement a. for 2010.

Project the amount of accounts receivable at year-end through Year +5 based on the accounts receivable

turnover computed in requirement a. Also compute the percentage change in accounts receivable

between each of the year-ends through Year +5.

c. Does the pattern of growth in your projections of Hart’s accounts receivable seem

reasonable considering the assumptions of smooth growth in sales and steady turnover? Explain.

d. The changes in accounts receivable computed in requirement b. display the sawtooth pattern depicted

in the text. Smooth the changes in accounts receivable by computing the year-end accounts receivable

balances for Year 1 through Year 5 using the compound annual growth rate in accounts receivable

between the end of 2010 and the end of Year +1 from requirement b.

e. Smooth the changes in accounts receivable using the compound annual growth rate in accounts

receivable between the end of 2010 and the end of Year +4 from requirement b. Apply this growth rate to

compute accounts receivable at the end of Year +1 through Year +5. Why do the amounts for ending

accounts receivable using the growth rate from requirement d. differ from those using the growth rate

from this requirement?

10–24

f. Compute the accounts receivable turnover for 2010 by dividing sales by the balance in accounts

receivable at the end of 2010 (instead of using average accounts receivable as in requirement a). Use this

accounts receivable turnover ratio to compute the projected balance in accounts receivable at the end of

Year +1 through Year +5. Also compute the percentage change in accounts receivable between the

year-ends for Year +1 through Year +5.

ANS:

b.

Percentage

Accounts Average Ending Accounts Receivable Change in

Receivable Accounts Beginning End of Accounts

c. The changes in receivables exhibit the sawtooth pattern described in the chapter. Such a

pattern does not seem reasonable in light of the assumptions of smooth growth in sales and

d. The increase in accounts receivable from $612 million at the of 2010 to $1,296 million at the

e. An increase in accounts receivable from $612 million to $1,034 million over four years

represents a compound annual rate of growth of 14.0 percent.

Ending Accounts Receivable

10–25

The difference in growth rate in Parts d. and e. results from using an ending accounts

f. Turnover based on year-end accounts receivable balance: $4,022/$612 = 6.57

Accounts Accounts Receivable Change in

Receivable Beginning End of Accounts

12. Benson sells books through retail stores and on the Web. For a retailer like Benson, inventory is a critical

element of the business and it is necessary to carry a wide array of titles. In 2010, sales totaled $5,122

million and cost of sales and occupancy totaled $3,541 million. Inventories constitute the largest asset on

Benson’s balance sheet, totaling $1,203 million at the end of 2010 and $1,358 million at the end of 2009.

Required

a. Compute the inventory turnover ratio for Benson for 2010.

b. Over the last two years, the number of Benson retail stores has remained fairly steady and sales have

grown at a compounded annual rate of 11.6 percent. Assume that the number of stores will remain

constant and that sales will continue to grow at an annual rate of 11.6 percent each year between Year +1

and Year +5. Also assume that the future cost of goods sold to sales percentage will equal that realized in

2010 (which is very similar to the cost of goods sold percentage over the past three years). Project the

amount of inventory at the end of Year +1 through Year +5 using the inventory turnover ratio computed

in Part a. Also compute the percentage change in inventories between each of the year-ends between

2010 and Year +5. Does the pattern of growth in your projections of Benson inventory seem reasonable

to you considering the assumptions of smooth growth in sales and steady cost of goods sold percentages?

Explain.

c. The changes in inventories in Part b display the sawtooth pattern depicted in Exhibit 10.5 of the text.

Smooth the changes in the inventory forecasts between 2010 and Year +5 using the compound annual

growth rate in inventories between the end of 2010 and the end of Year +5 implied by the projections in

Part b. Does this pattern of growth seem more reasonable? Explain.

d. Now suppose that instead of following the smoothing approach in Part c, you used the rate of growth

in inventory during 2010 to project future inventory balances at the end of Year +1 through Year +5. Use

these projections to compute the implied inventory turnover rates. Does this pattern of growth and

efficiency in inventory for Benson seem reasonable? Explain.

ANS:

(Assume Amounts in Thousands).

10–26

b. Cost of Inventories Percentage

Goods Inventory Average Beginning End of Change in

c. The above projections indicate an increase in inventories from $1,203 to $2,486 over five

years, representing a compound annual rate of growth of 15.62 percent [=

d. Benson inventories actually decreased from $1,358 at the end of 2009 to $1,203 at the end of

Ending Inventories Implied Turnover

Year +1 $1,203 x 0.886 = $1,066 $3,952/[($1,203 + $1,066)/2] = 3.48

Year +2 $1,066 x 0.886 = $944 $4,410/[($1,066 + $944)/2] = 4.39