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Comprehensive/Spreadsheet Problem
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b.
Problem 17-14 reworked:
a.
b.
Input Data:
Input Data:
A0*$2,700,000
Part I. Inputs
2015 2016
Growth rate, g NA 25% Tax rate (T) 40%
Adjustable Inputs
Fixed Inputs
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Chapter 17: Financial Planning and Forecasting
Part III. Balance Sheets 2015 Change 2016
Assets
Cash $1,800 (1+ g) $2,250.0
Part IV. Ratios and EPS 2015 2016E
Chapter 17: Financial Planning and Forecasting
Comprehensive/Spreadsheet Problem
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Part V. Notes on Calculations
Full capacity sales $48,000.00
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Integrated Case
Chapter 17: Financial Planning and Forecasting
Integrated Case
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New World Chemicals Inc.
Financial Forecasting
Sue Wilson, the new financial manager of New World Chemicals (NWC), a
California producer of specialized chemicals for use in fruit orchards, must
Table IC 17.1. Financial Statements and Other Data on NWC (Millions of Dollars)
A. Balance Sheets
2015 2016E
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B. Income Statements
2015 2016E
Sales $2,000.00 $2,500.00
C. Key Ratios
NWC (2015) NWC (2016E) Industry Comment
Basic earning power 10.00% 10.00% 20.00%
A. Assume (1) that NWC was operating at full capacity in 2015 with
respect to all assets, (2) that all assets must grow at the same rate
as sales, (3) that accounts payable and accrued liabilities also will
grow at the same rate as sales, and (4) that the 2015 profit margin
and dividend payout will be maintained. Under those conditions,
what would the AFN equation predict the company’s financial
requirements to be for the coming year?
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Answer: [Show S17-1 through S17-7 here.] NWC will need $180.9 million.
Here is the AFN equation:
B. Consultations with several key managers within NWC, including
production, inventory, and receivable managers, have yielded some
very useful information.
(1) NWC’s high DSO is largely due to one significant customer who
battled through some hardships the past 2 years but who
appears to be financially healthy again and is generating strong
cash flow. As a result, NWC’s accounts receivable manager
expects the firm to lower receivables enough for a calculated
DSO of 34 days without adversely affecting sales.
(2) NWC was operating slightly below capacity; but its forecasted
growth will require a new facility, which is expected to increase
NWC’s net fixed assets to $700 million.
(3) A relatively new inventory management system (installed last
year) has taken some time to catch on and to operate efficiently.
NWC’s inventory turnover improved slightly last year, but this
year NWC expects even more improvement as inventories
decrease and inventory turnover is expected to rise to 10.
Incorporate that information into the 2016 initial forecast results, as
these adjustments to the initial forecast represent the final forecast
for 2016. (Hint: Total assets do not change from the initial forecast.)
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Answer: [Show S17–8 through S17–10 here.]
Balance Sheets (In Millions of Dollars)
1st Pass Final Forecast
2015 2016 2016
Cash and equivalents $ 20 $ 25 $ 67e
Notes:
a DSO will be reduced to 34 days, without adversely affecting sales. Sales = $2,500;
DSO = 34; AR = ?
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C. Calculate NWC’s forecasted ratios based on its final forecast and
compare them with the company’s 2015 historical ratios, the 2016
initial forecast ratios, and the industry averages. How does NWC
compare with the average firm in its industry, and is the company’s
financial position expected to improve during the coming year?
Explain.
Answer: [Show S17-11 here.]
Key Ratios
1st Pass
Final
2015
2016
2016
Industry
Comment
Basic earning power
10.00%
10.00%
10.00%
20.00%
Low
Profit margin
2.52
2.62
2.62
4.00
Low
Return on equity
7.20
8.77
8.77
15.60
Low
DSO (365 days)
43.80 days
34.00 days
32.00 days
Inventory turnover
Fixed assets turnover
4.00
4.00
3.57
5.00
Low
Total assets turnover
2.00
2.00
2.00
2.50
Total liabilities/Assets
30.00%
40.40%
40.40%
36.00%
Times interest earned
Low
Current ratio
2.50
1.98
1.75
3.00
Low
Compared with industry averages, the firm’s inventory
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D. Based on the final forecast, calculate NWC’s free cash flow for 2016.
How does this FCF differ from the FCF forecasted by NWC’s initial
“business as usual” forecast?
Answer: [Show S17-12 and S17-13 here.]
FCF = EBIT(1 – T) + Depreciation –
+
NOWC
esexpenditur
capital Gross
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E. Initially, some NWC managers questioned whether the new facility
expansion was necessary, especially as it results in increasing net
fixed assets from $500 million to $700 million (a 40% increase).
However, after extensive discussions about NWC needing to position
itself for future growth and being flexible and competitive in today’s
marketplace, NWC’s top managers agreed that the expansion was
necessary. Among the issues raised by opponents was that NWC’s
fixed assets were operating at only 85% of capacity. Assuming that
its fixed assets were being operated at only 85% of capacity, by how
much could sales have increased, both in dollar terms and in
percentage terms, before NWC reached full capacity?
Answer: [Show S17-14 and S17-15 here.]
Full capacity sales =
operated FA were
at whichcapacity of %
sales Actual
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F. How would changes in the following items affect the AFN?
(Consider each item separately and hold all other things constant.)
(1) The dividend payout ratio.
Answer: [Show S17-16 here.] If the payout ratio were reduced, then more
earnings would be retained, and this would reduce the need for
F. (2) The profit margin.
Answer: If the profit margin increases, then both total and additions to
F. (3) The capital intensity ratio.
Answer: The capital intensity ratio is defined as the ratio of required assets
to total sales, or A0*/S0. Put another way, it represents the dollars
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F. (4) NWC beginning to buy from its suppliers on terms that permit it to
pay after 60 days rather than after 30 days.
Answer: If NWC’s payment terms were increased from 30 to 60 days, accounts