Chapter 04: Financial Forecasting
Chapter 4
Financial Forecasting
Discussion Questions
4-1.
What are the basic benefits and purposes of developing pro forma statements and
a cash budget?
The pro-forma financial statements and cash budget enable the firm to determine
its future level of asset needs and the associated financing that will be required.
Furthermore, one can track actual events against the projections. Bankers and
other lenders also use these financial statements as a guide in credit decisions.
4-2.
Explain how the collections and purchases schedules are related to the borrowing
needs of the corporation.
The collections and purchase schedules measure the speed at which receivables
are collected and purchases are paid. To the extent collections do not cover
purchasing costs and other financial requirements, the firm must look to
borrowing to cover the deficit.
4-3.
With inflation, what are the implications of using LIFO and FIFO inventory
methods? How do they affect the cost of goods sold?
LIFO inventory valuation assumes the latest purchased inventory becomes part
of the cost of goods sold, while the FIFO method assigns inventory items that
were purchased first to the cost of goods sold. In an inflationary environment, the
LIFO method will result in a higher cost of goods sold figure and one that more
accurately matches the sales dollars recorded at current dollars.
4-4.
Explain the relationship between inventory turnover and purchasing needs.
The more rapid the turnover of inventory, the greater the need for purchase and
replacement. Rapidly turning inventory makes for somewhat greater ease in
foreseeing future requirements and reduces the cost of carrying inventory.
4-5.
Rapid corporate growth in sales and profits can cause financing problems.
Elaborate on this statement.
Rapid growth in sales and profits is often associated with rapid growth in asset
commitment. A $100,000 increase in sales may cause a $50,000 increase in
assets, with perhaps only $10,000 of the new financing coming from profits. It is
very seldom that incremental profits from sales expansion can meet new
financing needs.
Chapter 04: Financial Forecasting
4-6.
Discuss the advantage and disadvantage of level production schedules in firms
with cyclical sales.
Level production in a cyclical industry has the advantage of allowing for the
maintenance of a stable work force and reducing inefficiencies caused by
shutting down production during slow periods and accelerating work during
crash production periods. A major drawback is that a large stock of inventory
may be accumulated during the slow sales period. This inventory may be
expensive to finance, with an associated danger of obsolescence.
4-7.
What conditions would help make a percent-of-sales forecast almost as accurate
as pro forma financial statements and cash budgets?
The percent-of-sales forecast is only as good as the functional relationship of
assets and liabilities to sales. To the extent that past relationships accurately
depict the future, the percent-of-sales method will give values that reasonably
represent the values derived through the pro-forma statements and the cash
budget.
Chapter 4
Problems
1. Growth and financing (LO4) Philip Morris is excited because sales for his clothing
company are expected to double from $500,000 to $1,000,000 next year. Philip notes that
net assets (Assets − Liabilities) will remain at 50 percent of Sales. His clothing firm will
enjoy a 9 percent return on total sales. He will start the year with $100,000 in the bank and
is already bragging about the two Mercedes he will buy and the European vacation he will
take. Does his optimistic outlook for his cash position appear to be correct?
Compute his likely cash balance or deficit for the end of the year. Start with beginning
cash and subtract the asset buildup (equal to 50 percent of the sales increase) and add in
profit.
Chapter 04: Financial Forecasting
4-3
4-1. Solution:
Philip Morris
Beginning cash $100,000
2. Growth and financing (LO4) In Problem 1 if there had been no increase in sales and all
other facts were the same, what would Philip’s ending cash balance be? What lesson do the
examples in Problems 1 and 2 illustrate?
4-2. Solution:
Philip Morris (continued)
Beginning cash $100,000
No asset buildup —–
firm.
Chapter 04: Financial Forecasting
4-4
3. Growth and financing (LO4) Galehouse Gas Stations Inc., expects sales to increase from
$1,500,000 to $1,700,000 next year. Mr. Galehouse believes that net assets (Assets −
Liabilities) will represent 70% of sales. His firm has a 10 percent return on sales and pays
40% of profits out as dividends.
a. What effect will this growth have on funds?
b. If the dividend payout is only 15%, what effect will this growth have on funds?
4-3. Solution:
Galehouse Gas Stations, Inc.
a. Asset buildup ($140,000) (70% × $200,000)
b. Dividends would only be $25,500 (15% × $170,000).
The change in cash would be a positive $4,500.
4. Sales projections (LO2) The Alliance Corp. expects to sell the following number of units
of copper cables at the prices indicated, under three different scenarios in the economy. The
probability of each outcome is indicated. What is the expected value of the total sales
projection?
Outcome Probability Units Price
A 0.30 200 $15
B 0.50 320 30
C 0.20 410 40
Chapter 04: Financial Forecasting
4-5
4-4. Solution:
Alliance Corporation
(1)
(3)
(4)
(5)
(6)
Outcome
Units
Price
Total
Value
Expected
Value
(2 × 5)
A
200
$15
$3,000
$ 900
B
320
$30
9,600
4,800
C
410
$40
16,400
3,280
Total expected value
$8,980
5. Sales projections (LO2) Bronco Truck Parts expects to sell the following number of units
at the prices indicated under three different scenarios in the economy. The probability of
each outcome is indicated. What is the expected value of the total sales projection?
Outcome Probability Units Price
A 0.20 300 $16
B 0.50 500 $25
C 0.30 1,000 $30
4-5. Solution:
Bronco Truck Parts
(1)
(2)
(3)
(4)
(5)
(6)
Outcome
Probability
Units
Price
Total
Value
Expected
Value
(2 × 5)
A
.20
300
$16
$4,800
$ 960
B
.50
500
25
12,500
6,250
C
.30
1,000
30
30,000
9,000
Total expected value
$16,210
Chapter 04: Financial Forecasting
4-6
6. Sales projections (LO2) Cyber Security Systems had sales of 3,000 units at $50 per unit
last year. The marketing manager projects a 20 percent increase in unit volume sales this
year with a 10 percent price increase. Returned merchandise will represent 6 percent of
total sales. What is your net dollar sales projection for this year?
4-6. Solution:
Cyber Security Systems
Unit volume 3,000 × 1.20……………………. 3,600
7. Sales projections (LO2) Dodge Ball Bearings had sales of 10,000 units at $20 per unit last
year. The marketing manager projects a 30 percent increase in unit volume sales this year
with a 5 percent price decrease (due to a price reduction by a competitor). Returned
merchandise will represent 3 percent of total sales. What is your net dollar sales projection
for this year?
4-7. Solution:
Dodge Ball Bearings
Unit volume 10,000 × 1.30 ………………….. 13,000
Chapter 04: Financial Forecasting
4-7
8. Production requirements (LO2) Sales for Western Boot Stores are expected to be 40,000
units for October. The company likes to maintain 15 percent of unit sales for each month in
ending inventory (i.e., the end of October). Beginning inventory for October is 8,500 units.
How many units should Western Boot produce for the coming month?
4-8. Solution:
Western Boot Stores
+ Projected sales ……………………………. 40,000 units
9. Production requirements (LO2) Vitale Hair Spray had sales of 8,000 units in March. A
50 percent increase is expected in April. The company will maintain 5 percent of expected
unit sales for April in ending inventory. Beginning inventory for April was 400 units. How
many units should the company produce in April?
4-9. Solution:
Vitale Hair Spray
+ Projected sales ………………………. 12,000 units (8,000 × 1.50)
10. Production requirements (LO2) Delsing Plumbing Company has beginning inventory of
14,000 units, will sell 50,000 units for the month, and desires to reduce ending inventory to
40 percent of beginning inventory. How many units should Delsing produce?
4-10. Solution:
Chapter 04: Financial Forecasting
4-8
Delsing Plumbing Company
+ Projected sales ………………………. 50,000 units
11. Cost of goods sold—FIFO (LO2) On December 31 of last year, Wolfson Corporation had
in inventory 400 units of its product, which cost $21 per unit to produce. During January,
the company produced 800 units at a cost of $24 per unit. Assuming that Wolfson
Corporation sold 700 units in January, what was the cost of goods sold (assume FIFO
inventory accounting)?
4-11. Solution:
Wolfson Corporation
Cost of goods sold on 700 units
Old inventory:
Quantity (Units) ……………… 400
Cost per unit ………………….. $ 21
Chapter 04: Financial Forecasting
4-9
12. Cost of goods sold—FIFO (LO2) At the end of January, Higgins Data Systems had an
inventory of 600 units, which cost $16 per unit to produce. During February the company
produced 850 units at a cost of $19 per unit. If the firm sold 1,100 units in February, what
was its cost of goods sold (assume LIFO inventory accounting)?
4-12. Solution:
Higgins Data System
Cost of goods sold on 1,100 units
New inventory:
13. Cost of goods sold—LIFO and FIFO (LO2) At the end of January, Mineral Labs had an
inventory of 725 units, which cost $10 per unit to produce. During February the company
produced 650 units at a cost of $14 per unit. If the firm sold 1,000 units in February, what
was the cost of goods sold?
a. Assume LIFO inventory accounting.
b. Assume FIFO inventory accounting.
4-13. Solution:
Chapter 04: Financial Forecasting
4-10
Mineral Labs
a. LIFO Accounting
Cost of goods sold on 1,000 units
New inventory:
Quantity (Units)……………………………… 650
b. FIFO Accounting
Cost of goods sold on 1,000 units
Old inventory:
Quantity (Units)……………………………… 725
14. Gross profit and ending inventory (LO2) The Bradley Corporation produces a product
with the following costs as of July 1, 2011:
Material ……………. $ 2 per unit
Labor ……………….. 4 per unit
Overhead ………….. 2 per unit