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
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
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
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
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
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 workforce and reducing inefficiencies caused by
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
Chapter 4
Problems
1. Growth and financing (LO4) Eli Lilly is very excited because sales for his nursery and
plant company are expected to double from $600,000 to $1,200,000 next year. Eli notes
that net assets (Assets — Liabilities) will remain at 50 percent of sales. His firm will enjoy
an 8 percent return on total sales. He will start the year with $120,000 in the bank and is
bragging about the Jaguar and luxury townhouse he will buy. 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.
4.1. Solution:
Eli Lilly
Beginning cash $120,000
2. Growth and financing (LO4) Philip Morris expects the sales for his clothing company to
be $550,000 next year. Philip notes that net assets (Assets – Liabilities) will remain
unchanged. His clothing firm will enjoy a 12 percent return on total sales. He will start the
year with $150,000 in the bank. What will Philip’s ending cash balance be?
4-2. Solution:
Philip Morris (Continued)
Beginning cash $150,000
No asset buildup —–
The lesson to be learned is that increased sales can increase the
3. Growth and financing (LO4) Galehouse Gas Stations Inc. expects sales to increase from
$1,550,000 to $1,750,000 next year. Galehouse believes that net assets (Assets
Liabilities) will represent 50 percent of sales. His firm has an 8 percent return on sales and
pays 45 percent of profits out as dividends.
a. What effect will this growth have on funds?
b. If the dividend payout is only 25 percent, what effect will this growth have on funds?
4-3. Solution:
Galehouse Gas Stations Inc.
a. Asset buildup ($100,000) (50% × $200,000)
b. Dividends would only be $35,000 (25% × $140,000).
The change in cash would be a positive $5,000.
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 0.70 225 $20
B 0.10 370 35
C 0.20 510 45
4-4. Solution:
Alliance Corporation
(1) (2) (3) (4) (5) (6)
Outcome Probability Units Price
Total
Value
Expected
Value
(2 × 5)
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 0.40 350 $21
B 0.10 600 $30
C 0.50 1,050 $35
4-5. Solution:
Bronco Truck Parts
(1) (2) (3) (4) (5) (6)
Outcome Probability Units Price
Total
Value
Expected
Value
(2 × 5)
6. Sales projections (LO2) Cyber Security Systems had sales of 3,500 units at $75 per unit
last year. The marketing manager projects a 30 percent increase in unit volume sales this
year with a 40 percent price increase. Returned merchandise will represent 8 percent of
total sales. What is your net dollar sales projection for this year?
4-6. Solution:
Cyber Security Systems
7. Sales projections (LO2) Dodge Ball Bearings had sales of 15,000 units at $45 per unit last
year. The marketing manager projects a 30 percent increase in unit volume sales this year
with a 20 percent price decrease (due to a price reduction by a competitor). Returned
merchandise will represent 8 percent of total sales. What is your net dollar sales projection
for this year?
4-7. Solution:
Dodge Ball Bearings
8. Production requirements (LO2) Sales for Ross Pro’s Sports Equipment are expected to
be 4,800 units for the coming month. The company likes to maintain 10 percent of unit
sales for each month in ending inventory. Beginning inventory is 300 units. How many
units should the firm produce for the coming month?
4-8. Solution:
Ross Pro’s Sports Equipment
9. Production requirements (LO2) Vitale Hair Spray had sales of 13,000 units in March. A
70 percent increase is expected in April. The company will maintain 30 percent of expected
unit sales for April in ending inventory. Beginning inventory for April was 650 units. How
many units should the company produce in April?
4-9. Solution:
Vitale Hair Spray
10. Production requirements (LO2) Delsing Plumbing Company has beginning inventory of
16,500 units, will sell 55,000 units for the month, and desires to reduce ending inventory to
25 percent of beginning inventory. How many units should Delsing produce?
4-10. Solution:
Delsing Plumbing Company
+ Projected sales……………………….. 55,000 units
11. Cost of goods sold—FIFO (LO2) On December 31 of last year, Wolfson Corporation had
an inventory of 450 units of its product, which cost $22 per unit to produce. During
January, the company produced 850 units at a cost of $25 per unit. Assuming that Wolfson
Corporation sold 800 units in January, what was the cost of goods sold? (Assume FIFO
inventory accounting.)
4-11. Solution:
Wolfson Corporation
Cost of goods sold on 800 units
Old inventory:
Quantity (units)………………. 450
New inventory:
Quantity (units)………………. 350
12. Cost of goods sold—FIFO (LO2) At the end of January, Higgins Data Systems had an
inventory of 650 units, which cost $16 per unit to produce. During February, the company
produced 950 units at a cost of $19 per unit. If the firm sold 1,150 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 1,150 units
New inventory:
Quantity (units)……………. 950
Old inventory:
Quantity (units)……………. 200
13. Cost of goods sold—LIFO and FIFO (LO2) At the end of January, Mineral Labs had an
inventory of 775 units, which cost $12 per unit to produce. During February, the company
produced 900 units at a cost of $16 per unit. If the firm sold 1,500 units in February, what
was the cost of goods sold?
a. Assume LIFO inventory accounting.
b. Assume FIFO inventory accounting.
4-13. Solution:
Mineral Labs
a. LIFO Accounting
Cost of goods sold on 1,500 units
New inventory:
Old inventory:
Quantity (units)………………………………. 600
b. FIFO Accounting
Cost of goods sold on 1,000 units
Old inventory:
New inventory:
Quantity (units)………………………………. 725
14. Gross profit and ending inventory (LO2) Convex Mechanical Supplies produces a
product with the following costs as of July 1, 20X1:
Material…………………….. $ 6
Labor………………………… 4
Overhead…………………… 2
$12
Beginning inventory at these costs on July 1 was 5,000 units. From July 1 to December 1,
Convex produced 15,000 units. These units had a material cost of $10 per unit. The costs
for labor and overhead were the same. Convex uses FIFO inventory accounting.
Assuming that Convex sold 17,000 units during the last six months of the year at $20 each,
what would gross profit be? What is the value of ending inventory?
4-14. Solution:
Convex Mechanical Supplies
Sales (17,000 @ $20) $340,000
Cost of goods sold:
Old inventory:
New inventory:
Total cost of goods
Value of ending
inventory:
Beginning inventory
or
3,000 units $16 = $48,000
15. Gross profit and ending inventory (LO2) The Bradley Corporation produces a product
with the following costs as of July 1, 20X1:
Material…………….. $4 per unit
Labor………………… 4 per unit
Overhead 2 per unit
Beginning inventory at these costs on July 1 was 3,250 units. From July 1 to December
1, 20X1, Bradley produced 12,500 units. These units had a material cost of $5, labor of $4,
and overhead of $5 per unit. Bradley uses LIFO inventory accounting.
Assuming that Bradley sold 14,000 units during the last six months of the year at $19
each, what is its gross profit? What is the value of ending inventory?