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12-9 Garlington Technologies Inc.
Pro Forma Income Statement
December 31, 2017
Forecast Pro Forma
2016 Basis 2017
Sales $3,600,000 1.10 Sales16 $3,960,000
Operating costs 3,279,720 0.911 Sales17 3,607,692
EBIT $ 320,280 $ 352,308
Garlington Technologies Inc.
Pro Forma Balance Statement
December 31, 2017
Forecast
Basis % AFN With AFN
2016 2017 Sales Additions 2017 Effects 2017
Cash $ 180,000 0.05 $ 198,000 $ 198,000
Receivables 360,000 0.10 396,000 396,000
Inventories 720,000 0.20 792,000 792,000
Total curr. assets $1,260,000 $1,386,000 $1,386,000
Answers and Solutions: 12 - 1
© 2017 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
*See income statement.
The additional investment in assets is equal to the change in total assets because there are
not short-term investments:
The additional financing from the increase in spontaneous liabilities and from the
reinvested earnings is:
Financing surplus (deficit) = Additional financing – Additional assets
Because this is negative, it is a financing deficit. This means the LOC should be
$128,783.
Answers and Solutions: 12 - 2
© 2017 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
SOLUTION TO SPREADSHEET PROBLEMS
12-10 The detailed solution is available in the file Ch12 P10 Build a Model Solution.xlsx at the
textbook’s Web site.
12-11 The detailed solution for is available in the file Ch12 P11 Build a Model Solution.xlsx at
the textbook’s Web site.
Answers and Solutions: 12 - 3
© 2017 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
MINI CASE
Hatfield Medical Supply’s stock price had been lagging its industry averages, so its
board of directors brought in a new CEO, Jaiden Lee. Lee had brought in Ashley Novak, a
finance MBA who had been working for a consulting company, to replace the old CFO, and
Lee asked Ashley to develop the financial planning section of the strategic plan. In her
previous job, Novak’s primary task had been to help clients develop financial forecasts, and
that was one reason Lee hired her.
Novak began as she always did, by comparing Hatfield’s financial ratios to the
industry averages. If any ratio was substandard, she discussed it with the responsible
manager to see what could be done to improve the situation. The following data shows
Hatfield’s latest financial statements plus some ratios and other data that Novak plans to
use in her analysis.
Hatfield Medical Supply (Millions of Dollars Except Per Share Data)
Balance Sheet, 12/31/2016 Income Statement, Year Ending 2016
Cash $ 20 Sales $2,000
Accts. rec. 280 Op. costs (excl. depr.) 1,800
Taxes (40%) 44
Accts. pay. & accruals $ 80 Net income $ 66
Line of credit $0
Total CL $ 80 Dividends $20.0
Answers and Solutions: 12 - 4
© 2017 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Selected Additional Data for 2016
Hatfield
Industr
y Hatfield Industry
(Op. costs)/Sales 90.0% 88.0% (Total liabilities)/(Total assets) 48.3% 36.7%
Depr./FA 10.0% 12.0% Times interest earned 3.8 8.9
Cash/Sales 1.0% 1.0% Return on assets (ROA) 5.5% 10.2%
Note: Hatfield was operating at full capacity in 2016. Also, you may observe small differences in items like the
ROE when calculated in different ways. Any such differences are due to rounding, and they can be ignored.
Answers and Solutions: 12 - 5
© 2017 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
a. Using Hatfield’s data and its industry averages, how well run would you say
Hatfield appears to be in comparison with other firms in its industry? What are
its primary strengths and weaknesses? Be specific in your answer, and point to
various ratios that support your position. Also, use the DuPont equation (see
Chapter 3) as one part of your analysis.
Answer: The DuPont equation shows the relationship among asset management, profitability
ratios, and leverage. By examining this equation we can determine where Hatfield
falls short of the industry.
ROEHatfield = Profit margin × Asset turnover ×(Equity multiplier)
ROEIndustry = Profit margin × Asset turnover ×(Equity multiplier)
From the DuPont equation, you can see that Hatfield’s profitability and asset
management ratios are lower than the industry average and its leverage is higher than
the industry average. The combined effect results in a much lower return on equity
Answers and Solutions: 12 - 6
© 2017 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
b. Use the AFN equation to estimate Hatfield’s required new external capital for
2017 if the sales growth rate is 10%. Assume that the firm’s 2016 ratios will
remain the same in 2017. (Hint: Hatfield was operating at full capacity in 2016.)
Answer:
Data for AFN Equation
Growth rate in sales (g) 10%
Sales (S0) $2,000
Here is the AFN equation:
AFN = (A0*/S0)∆S – (L0*/S0)∆S – M(S1)(1 – Payout)
c. Define the term capital intensity. Explain how a decline in capital intensity
would affect the AFN, other things held constant. Would economies of scale
combined with rapid growth affect capital intensity, other things held constant?
Also, explain how changes in each of the following would affect AFN, holding
other things constant: the growth rate, the amount of accounts payable, the
profit margin, and the payout ratio.
Answer: The capital intensity ratio is the amount of assets required per dollar of sales, A0*/S0,
and it has a major effect on capital requirements. A decline in the capital intensity
Answers and Solutions: 12 - 7
© 2017 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
Rapidly growing companies require large increases in assets and a corresponding
large amount of external financing, other things held constant. Accounts payable are
spontaneous liabilities that come about due to normal day-to-day business operations.
d. Define the term self-supporting growth rate. What is Hatfield’s self-supporting
growth rate? Would the self-supporting growth rate be affected by a change in
the capital intensity ratio or the other factors mentioned in the previous
question? Other things held constant, would the calculated capital intensity ratio
change over time if the company were growing and were also subject to
economies of scale and/or lumpy assets?
Answer: The self-supporting growth rate is the maximum growth rate the firm could achieve if
it had no access to external capital. From the data given, Hatfield’s self-supporting
growth rate is calculated as:
Self-supporting g = [M(1 – POR)(S0)]/[A0* – L0* – M(1 – POR)(S0)]
Self-supporting g = [M(1 – POR)(S0)]/[A0* – L0* – M(1 – POR)(S0)]
The higher the firm’s capital intensity ratio, the lower the firm’s self-supporting
Answers and Solutions: 12 - 8
© 2017 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
The calculated capital intensity ratio will change over time if the firm company is
expanding and if economies of scale and lumpy assets exist. When economies occur,
the capital intensity ratio will change over time as the size of the firm increases. In
Answers and Solutions: 12 - 9
© 2017 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible
website, in whole or in part.
