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1.
The capital intensity ratio can be defined as the level of assets needed to support a
given level of sales, and we might expect to observe differences in this ratio between
different industries.
A.
B.
2.
Holding all other factors constant, such as interest expense and dividends, an increase
in the cost of goods sold should increase a firms need for additional capital.
A.
B.
3.
Errors in the sales forecast can be offset by similar errors in costs and income forecasts.
Thus, as long as the errors are not large, sales forecast accuracy is not critical to the
firm.
*
4.
*
5.
*
6.
A.
B.
True
False
True
False
True
False
The term "spontaneously generated funds" generally refers to increases in the cash
account that result from growth in sales, assuming the firm is operating with a positive
profit margin.
A.
B.
True
False
Additional funds needed are typically raised from some combination of notes payable,
accounts payable, accruals, long-term bonds, and common stock. We can consider
these accounts to be non-spontaneous, since they require an explicit financing decision
by the form to increase them.
A.
B.
True
False
The net present value (NPV) method assumes that intervening cash flows will be
reinvested at the risk-free rate, while the internal rate of return (IRR) method assumes
that intervening cash flows will be reinvested at the firms cost of capital.
A.
B.
True
False
Page 1 of 57 Pages
7.
An increase in the firm's inventory balance will normally require additional financing
unless the increase is matched by an equally large decrease in some other asset
account.
A.
B.
8.
To determine the amount of additional funds needed, you may subtract the expected
increase in liabilities (a source of funds) from the sum of the expected increases in
retained earnings and assets (both uses of funds).
1.
A.
B.
True
False
True
False
Simply due to its mathematical basis, the equation model for percent of sales
forecasting will produce a more accurate forecast than a spreadsheet model.
As long as the firm is currently operating at full capacity, fixed assets should be
set as a constant percent of sales, even if they may be somewhat lumpy in
reality.
Although the firm may exhibit economies of scale, the percentages that we
observe for individual assets (such as cash, inventory, fixed assets, etc.) will
not vary over time as the sales of the firm change.
A disadvantage of the spreadsheet model is that it is not easy to include
changes in a firms profit margin, changes in its dividend policy, planned
acquisitions of assets, or repayments of liabilities.
Determining additional funds needed (AFN) may require an iterative solution,
since financing charges may lead to circular relationships: income statement
determines additions to the balance sheet, which determines funding needs,
which determine financing charges, which determines the income statement,
and so on.
E.
2.
C.
If a firm forecasts a large need for additional funds needed, a good strategy to
raise the capital is to increase the dividend payout rate.
Suppose a firm is operating its fixed assets below 100 percent capacity (and
assuming that it cannot sell or lease these assets) but is at 100 percent with
respect to current assets. If sales grow, the firm can offset the needed
increase in current assets simply by switching production to its idle fixed
assets.
Additional funds needed are typically raised from some combination of notes
payable, long-term bonds, and common stock. These accounts are
nonspontaneous in that they require an explicit financing decision to increase
them.
Page 2 of 57 Pages
D.
E.
3.
If a firm retains all of its earnings, then it will not need any additional funds to
support sales growth.
None of the statements above is correct.
Considering each action independently and holding other things constant, which of the
following actions would reduce a firm's need for additional capital?
A.
B.
C.
D.
E.
4.
B.
C.
D.
A firm can use regression analysis for specific item forecasting, such as
inventory. However, regression analysis can also be used in conjunction with
the Capital Asset Pricing Model (CAPM) to determine the required rate of
return on a firms stock: that is, we can use regression analysis to calculate a
stocks beta coefficient.
One of the advantages of using the spreadsheet model to calculate a firms
AFN is that it is easier to incorporate such things as economies of scale and
lumpy assets than when using the equation model.
Financial forecasts should consider the effect of inflation on future prices.
Unfortunately, simply observing that total dollar sales are expected to increase
in the future does not mean that planners have included the effect of inflation
on future prices. The increase in dollar sales could simply be due to the fact
that more units will be sold, not that each unit will be sold at a higher price.
One way of looking at percent of sales forecasting is in terms of sources and
uses of funds. Percentage of sales forecasting can tell us how much assets
are expected to increase in the future. However, this increase in assets is a
use of funds that must be offset by a source of funds. Some of the funds may
come from spontaneously increasing liabilities. Some of the funds may come
from additions to the firms retained earnings. The remaining funds are
additional funds needed and their source is determined by management.
Certain liabilities generally increase spontaneously with sales. These would
include any of the firms current liabilities, such as accounts payable, notes
payable, accruals, and capital leases, but would not include long-term liabilities
such as long-term debt or even equity.
E.
5.
Page 3 of 57 Pages
B.
C.
*
D.
E.
6.
D.
E.
7.
B.
C.
D.
E.
8.
If the capital intensity ratio is high, this permits sales to grow more rapidly
without much outside capital.
The lower the profit margin, the lower the additional funds needed because
less assets are needed to support existing sales.
When positive economies of scale are present, linear balance sheet
relationships no longer hold. As sales increase, a proportionately greater stock
of assets is required to support the higher sales level.
Technological considerations often require firms to add fixed assets in large,
discrete units. Such assets are called lumpy assets and they affect the firms
financial requirements through the fixed assets/sales ratio at different sales
levels.
The percent of sales method accounts for changing balance sheet ratios and
thus, cyclical changes in the actual sales to assets ratio do not have an impact
on financing requirements.
Page 4 of 57 Pages
A.
B.
C.
*
D.
E.
9.
10.
Considering each action independently and holding all other factors constant, which of
the following actions would increase a firm's need for additional capital?
A.
B.
C.
D.
E.
B.
C.
D.
E.
1.
U.S. Treasury Bonds, bankers acceptances, and commercial paper are all
examples of capital market instruments.
If the maturity risk premium (MRP) is greater than zero, then the yield curve
must be upward sloping.
Additional funds needed are best defined as the amount of cash generated in a
given year minus the amount of cash needed to finance the additional capital
expenditures and working capital needed to support the firms growth.
The percent of sales method is based on the assumptions that most balance
sheet accounts are tied directly to sales and that the current level of total
assets is optimal for the current sales level.
The yield on a 3-years corporate bond will always exceed the yield on a 2-year
corporate bond.
You have been given the attached information for your company.
Sales
Operating Costs
EBIT
Interest
2002 Actual
$5,000.00
-$3,500.00
2003 Forecast
$1,500.00
-$200.00
Page 5 of 57 Pages
EBT
Taxes (40%)
Net Income
Number of Shares Outstanding
$1,300.00
-$520.00
$780.00
1,000
Total Dividends
$500.00
Addition to RE
$280.00
Current Assets
Net Fixed Assets
Total Assets
A/P and Accruals
2002 Actual
$5,000.00
$2,500.00
1,000
2003 Forecast
$7,500.00
$500.00
Debt
$2,000.00
Common Stock
Retained Earnings
$1,000.00
$5,000.00
$7,500.00
You should now be able to do a first pass and determine the additional funds needed
(AFN). Remember that dividends are paid out of retained earnings, so increasing or
decreasing the dividend payment will affect the amount of retained earnings and,
therefore, the additional funds needed. What would the dividend per share have to be
so that the additional funds needed are zero?
A.
B.
C.
D.
$1.149 / share
$1.099 / share
$1.199 / share
$1.049 / share
Page 6 of 57 Pages
E.
$1.249 / share
2002 Actual
$5,000.00
-$3,500.00
2003 Forecast
$5,750.00
-$3,910.00
EBIT
Interest
$1,500.00
-$200.00
$1,840.00
-$300.00
EBT
Taxes (40%)
$1,300.00
-$520.00
$1,540.00
-$616.00
$780.00
$924.00
1,000
1,000
Total Dividends
$500.00
$550.00
Addition to RE
$280.00
$374.00
2002 Actual
$5,000.00
$2,500.00
2003 Forecast
$5,750.00
$3,500.00
$7,500.00
$9,250.00
$500.00
$575.00
Debt
$2,000.00
$3,000.00
Common Stock
Retained Earnings
$1,000.00
$5,000.00
$1,000.00
$5,374.00
$7,500.00
$9,949.00
Sales
Operating Costs
Net Income
Number of Shares Outstanding
Current Assets
Net Fixed Assets
Total Assets
A/P and Accruals
-$699.00
2.
Assume that you observe the following percentage returns (in decimal form) for the
Market and for Firm A. Use regression analysis to determine how the returns for Firm
A are related to the returns for the Market (determine the intercept and slope, setting
the Market as the independent variable and Firm A as the dependent variable), then
calculate the best guess for what the returns on Firm A will be in 2003, if the return on
the market in 2003 is 8 percent (0.08). Note: You must use your financial calculator.
You cannot calculate the slope using rise/run.
Year
Market
Firm A
Page 7 of 57 Pages
2002
2001
2000
1999
1998
*
- .10
.15
.20
.30
.28
A.
B.
C.
D.
E.
-.25
.00
.30
.64
.40
4.45%
5.05%
5.25%
4.65%
4.85%
+/- Input
Input
Input
Input
Input
0 y,m
SWAP
.08 y,m
.25
.00
.30
.64
.40
+/- +
+
+
+
+
-0.116929791 (intercept)
2.017649341 (slope)
0.044482157 (forecast) = 4.45%
Alternatively,
4.45% = 0.0445 = -.116929791 + (.08)(2.017649341) = -.116929791 + .161411947
YOU ARE GIVEN THE FOLLOWING INFORMATION FOR PROBLEMS 3 - 4:
Income Statement
Sales
Operating Costs
Year 2
$1,200.00
-$1,020.00
Depreciation
-$55.00
EBIT
$125.00
Interest
-$25.00
EBT
$100.00
Taxes (40%)
-$40.00
Net Income
$60.00
Dividends
$40.00
Assets
Year 2
Year 3
First Pass
$1,800.00
Year 3
Year 3
Second Pass
$1,800.00
Year 3
Page 8 of 57 Pages
Cash
Accounts Receivable
$15.00
$200.00
Inventories
$250.00
Current Assets
Gross Plant & Equipment
Less: Depreciation
Net Plant & Equipment
Total
First Pass
Second Pass
Year 3
First Pass
Year 3
Second Pass
$465.00
$1,100.00
-$555.00
$545.00
$1,010.00
Year 2
$120.00
$50.00
$80.00
Current Liabilities
Long-Term Debt
Common Stock
$250.00
$210.00
$382.00
Retained Earnings
$168.00
Total
$1,010.00
AFN
N/A
Page 9 of 57 Pages
3.
Do a first pass using the assumptions above and calculate the additional funds needed
(AFN).
A.
B.
C.
D.
E.
$982.00
$739.00
$896.00
$685.00
$802.00
Income Statement
Sales
Operating Costs
Year 2
Year 3
First Pass
$1,200.00
-$1,020.00
$1,800.00
-$1,440.00
Depreciation
-$55.00
-$155.00
EBIT
$125.00
$205.00
Interest
-$25.00
-$35.00
EBT
$100.00
$170.00
Taxes (40%)
-$40.00
-$68.00
Net Income
$60.00
$102.00
Dividends
$40.00
$51.00
Assets
Year 2
Year 3
First Pass
Cash
Accounts Receivable
$15.00
$200.00
$50.00
$300.00
Inventories
$250.00
$375.00
$465.00
$1,100.00
$725.00
$2,100.00
-$555.00
-$710.00
$545.00
$1,390.00
$1,010.00
$2,115.00
Current Assets
Gross Plant & Equipment
Less: Depreciation
Net Plant & Equipment
Total
Year 2
Year 3
First Pass
$120.00
$50.00
$180.00
$140.00
$80.00
$120.00
$250.00
$440.00
Year 3
Second Pass
Year 3
Second Pass
Year 3
Second Pass
Page 10 of 57 Pages
Long-Term Debt
Common Stock
$210.00
$382.00
$210.00
$350.00
Retained Earnings
$168.00
$219.00
Total
$1,010.00
$1,219.00
AFN
N/A
$896.00
4.
Now assume that the AFN determined above will be raised in the form of additional
long-term debt. Also assume that the interest rate on this additional debt will be 10
percent. Finally, assume that the firm plans to maintain its dividend payout rate at 50
percent of net income, where the new level of net income will now account for the
increase in interest expense. Do a second pass incorporating financial feedback
effects and calculate the new level of additional funds needed (AFN).
A.
B.
C.
D.
E.
$26.88
$37.39
$32.76
$49.64
$43.13
Income Statement
Sales
Operating Costs
Depreciation
EBIT
Year 2
Year 3
First Pass
Year 3
Second Pass
$1,200.00
-$1,020.00
-$55.00
$125.00
$1,800.00
-$1,440.00
-$155.00
$205.00
$1,800.00
-$1,440.00
-$155.00
$205.00
Interest
EBT
-$25.00
$100.00
-$35.00
$170.00
-$124.60
$80.40
Taxes (40%)
-$40.00
-$68.00
-$32.16
Net Income
$60.00
$102.00
$48.24
Dividends
$40.00
$51.00
$24.12
Assets
Year 2
Year 3
First Pass
Year 3
Second Pass
Cash
Accounts Receivable
$15.00
$200.00
$50.00
$300.00
$50.00
$300.00
Inventories
$250.00
$375.00
$375.00
$465.00
$1,100.00
$725.00
$2,100.00
$725.00
$2,100.00
-$555.00
-$710.00
-$710.00
$545.00
$1,390.00
$1,390.00
$1,010.00
$2,115.00
$2,115.00
Current Assets
Gross Plant & Equipment
Less: Depreciation
Net Plant & Equipment
Total
Page 11 of 57 Pages
Year 3
First Pass
Year 2
Accounts Payable
Notes Payable
Year 3
Second Pass
$120.00
$50.00
$180.00
$140.00
$180.00
$140.00
$80.00
$120.00
$120.00
Current Liabilities
Long-Term Debt
Common Stock
$250.00
$210.00
$382.00
$440.00
$210.00
$350.00
$440.00
$1,106.00
$350.00
Retained Earnings
$168.00
$219.00
$192.12
Total
$1,010.00
$1,219.00
$2,088.12
AFN
N/A
$896.00
$26.88
Accruals
Alternatively,
Increase in Interest at 10%
Interest Tax Shelter at 40%
Decrease in Net Income
Decline in Dividend (50%)
Decline in Additions to Retained Earnings
5.
New AFN
Assume that you observe the following percentage returns (in decimal form) for the
Market and for Security A. Use regression analysis to determine how the returns for
Security A are related to the returns for the Market (that is, calculate its beta or slope
coefficient). Based on these results, if the risk-free rate is expected to be 5 percent,
and the expected return on the market is expected to be 8 percent, then what is the
required rate of return for Firm A based on the capital asset pricing model (CAPM)
using the equation for the security market line (SML)?
Year
1
2
3
4
5
- $89.60
$35.84
- $53.76
+$26.88
- $26.88
A.
B.
C.
D.
E.
Market
- .20
- .10
.10
.00
.25
Security A
-.25
.00
.20
.35
.30
8.42%
8.85%
8.27%
8.59%
8.12%
+/- Input
.25
+/- +
Page 12 of 57 Pages
.10
.10
.00
.25
+/- Input
Input
Input
Input
0 y,m
SWAP
.00
.20
.35
.30
+
+
+
+
0.108606557 (intercept)
1.139344262 (slope)
6.
You have been given the attached information for your company. The company
expects sales to grow by 50 percent in 2003 and operating costs should increase in
proportion to sales. Fixed assets were being operated at 40 percent of capacity in
2002, but all other assets were used to full capacity. Underutilized fixed assets cannot
be sold. Current assets and spontaneous liabilities should increase in proportion to
sales during 2003. The company plans to finance any external funds needed as 35
percent notes payable and 65 percent common stock. Ignoring any financing
feedback effects, what is the companys ROE after adjusting for additional funds
needed?
Sales
Operating costs
EBIT
Interest
EBT
Taxes (40%)
Net income
2002
$1,000.00
800.00
$ 200.00
16.00
$ 184.00
73.60
$ 110.40
Dividends (60%)
Additions to R.E.
$ 66.24
$ 44.16
Current assets
Net fixed assets
Total assets
$ 700.00
300.00
$1,000.00
$ 150.00
200.00
150.00
500.00
$1,000.00
2003 Forecast
AFN
Profit margin
ROE
Debt/Assets
11.04%
16.98
35.00
Page 13 of 57 Pages
Current ratio
Payout ratio
2.00_
60.00%
AFN Financing:
N/P
Common stock
Weights
0.3500
0.6500
1.0000
Dollars
2002
$1,000.00
800.00
$ 200.00
16.00
$ 184.00
73.60
$ 110.40
2003 Forecast
$1,500.00
1,200.00
$ 300.00
16.00
$ 284.00
113.60
$ 170.40
Dividends (60%)
Additions to R.E.
$ 66.24
$ 44.16
$ 102.24
$ 68.16
$ 102.24
$ 68.16
Current assets
Net fixed assets*
Total assets
$ 700.00
300.00
$1,000.00
$1,050.00
300.00
$1,350.00
$1,050.00
300.00
$1,350.00
$ 150.00
200.00
150.00
500.00
$1,000.00
$ 225.00
200.00
150.00
568.16
$1,143.16
$ 225.00
272.39
284.45
568.16
$1,350.00
A.
B.
C.
D.
E.
19.99%
17.67%
21.73%
25.68%
23.24%
Sales
Operating costs
EBIT
Interest
EBT
Taxes (40%)
Net income
AFN
$ 206.84
Profit margin
ROE
Debt/Assets
Current ratio
Payout ratio
11.04%
16.98
35.00
2.00x
60.00%
11.36%
23.73
31.48
2.47x
60.00%
AFN Financing:
N/P
Common stock
Weights
0.3500
0.6500
1.0000
Dollars
72.39
134.45
206.84
11.36%
19.99
36.84
2.11x
60.00%
Page 14 of 57 Pages
7.
A well-managed company has reported the following sales and inventories over the
past three years:
Year
2000
2001
2002
Sales
$1,650,000
1,800,000
2,250,000
Inventories
$150,000
165,000
185,000
The company forecasts that its sales will be $2,800,000 in 2003, and the company
uses regression analysis (on the basis of the last three years' data) to forecast its
inventories. What are its forecasted inventories for 2003?
A.
B.
C.
D.
E.
$209,000.35
$225,689.95
$216,282.05
$231,000.25
$237,667.85
1,650,000 INPUT
1,800,000 INPUT
2,250,000 INPUT
150,000 +
165,000 +
185,000 +
8.
$ 15
20
15
30
70
Page 15 of 57 Pages
Total assets
$150
and equity
$150
Sales during 2002 were $200, and they are expected to rise by 50 percent to $300
during the coming year (2003). Also, during the last year fixed assets were being
utilized to only 85 percent of capacity, so your company could have supported $200 of
sales with fixed assets that were only 85 percent of last year's actual fixed assets.
Assume that your companys profit margin will remain constant at 5 percent, that the
company will continue to pay out 60 percent of its earnings as dividends, and that all
current assets and spontaneous liabilities will increase proportionately with sales. Do
a first pass (do not consider financing feedback effects) and determine what additional
funds will be needed (AFN) during the next year.
A.
B.
C.
D.
E.
$53.38
$49.76
$37.13
$40.29
$44.85
Total assets
$ 22.50
20.00
22.50
30.00
76.00
$171.00
9.
Over the past four years, your well-managed company has had the following link
between its inventories and its sales:
Year
1999
2000
Sales
$200 million
250 million
Inventories
$35 million
38 million
Page 16 of 57 Pages
2001
2002
400 million
500 million
55 million
70 million
Your company is in the process of generating its forecasted financial statements for
2003. The company first generates a forecast for sales and then, given its sales
forecast, uses a regression model (using data given above) to forecast its inventories
for 2003. Assuming that the forecasted sales for 2003 are $700 million, determine
what the forecasted inventories will be for 2003.
*
A.
B.
C.
D.
E.
$92.04
$89.64
$86.93
$95.20
$98.59
million
million
million
million
million
10.
You are given the actual income statement and balance sheet below for year-end
2002. Now make the following assumptions:
1.
2.
3.
4.
5.
6.
7.
8.
Sales are expected to increase from $4,000 to $4,400 in 2003 (10% increase).
Cost of goods sold is expected to decrease to 88 percent in 2003.
Current assets and spontaneously increasing liabilities can be expressed as a
percentage of sales.
Fixed plant and equipment is being used at 80 percent of capacity. If fixed
assets are increased, they must be increased in blocks of $500.
The firm expects to pay a dividend of $200 in 2003.
The firm expects to increase its debt to $750 at the beginning of 2003, resulting
in interest expense of $75 for 2003.
The firm expects to sell additional shares of common stock worth $100.
The firm expects to make any adjustments for additional funds needed (AFN)
through adjustments (increases or decreases) to the amount added through
retained earnings, or alternatively (decreases or increases) to the amount paid
out in dividends.
Page 17 of 57 Pages
Income Statement
2002
Actual
Sales
Operating Costs
$4,000.00
$3,600.00
EBIT
Interest (10%)
$400.00
$50.00
EBT
Taxes (40%)
$350.00
$140.00
Net Income
$210.00
Dividends
$150.00
Addition to RE
$60.00
Balance Sheet
2002
Actual
Current Assets
Net Fixed Assets
$5,000.00
$3,000.00
Total Assets
$8,000.00
$1,500.00
Debt
$500.00
Common Stock
Retained Earnings
$1,000.00
$5,000.00
$8,000.00
2003
Forecast
2003
After AFN
2003
Forecast
2003
After AFN
A.
B.
C.
D.
E.
$165.80
$198.80
$233.80
$271.80
$302.80
Income Statement
2002
Actual
2003
Forecast
2003
After AFN
Page 18 of 57 Pages
Sales
Operating Costs
$4,000.00
$3,600.00
$4,400.00
$3,872.00
$4,400.00
$3,872.00
EBIT
Interest (10%)
$400.00
$50.00
$528.00
$75.00
$528.00
$75.00
EBT
Taxes (40%)
$350.00
$140.00
$453.00
$181.20
$453.00
$181.20
Net Income
$210.00
$271.80
$271.80
Dividends
$150.00
$200.00
$271.80
Addition to RE
$60.00
$71.80
$0.00
Balance Sheet
2002
Actual
2003
Forecast
2003
After AFN
Current Assets
Net Fixed Assets
$5,000.00
$3,000.00
$5,500.00
$3,000.00
$5,500.00
$3,000.00
Total Assets
$8,000.00
$8,500.00
$8,500.00
$1,500.00
$1,650.00
$1,650.00
Debt
$500.00
$750.00
$750.00
Common Stock
Retained Earnings
$1,000.00
$5,000.00
$1,100.00
$5,071.80
$1,100.00
$5,000.00
$8,000.00
$8,571.80
$8,500.00
11.
-$71.80
You are given the following historical data for sales and inventory:
Year
2002
2001
2000
1999
1998
1997
Sales
$2,750.00
$2,600.00
$2,400.00
$1,950.00
$2,500.00
$2,000.00
Inventory
?
$725.00
$700.00
$650.00
$600.00
$500.00
Perform a regression analysis (the relationship is not strictly linear, so you will not be
able to use rise/run to determine the slope) and determine what inventory will be in
2002, rounded off to the nearest whole dollar.
A.
$692
Page 19 of 57 Pages
B.
C.
D.
E.
$716
$754
$781
$807
Using your calculator, you can use the following steps to perform your regression:
2000 Input
2500 Input
1950 Input
2400 Input
2600 Input
500 +
600 +
650 +
700 +
725 +
12.
Assets
Cash
Accounts Receivable
Inventories
Net Fixed Assets
2004
$1,600
$900
$1,900
$68,000
Total Assets
$72,400
2004
$700
$300
$4,000
$53,000
$6,400
$8,000
$72,400
Assume that you expect sales in 2005 to increase from $20,000 to $40,000, increasing net
income to $2,000, all of which will be added to retained earnings. Also assume that you
feel that you can handle the increase in sales without adding any fixed assets, but that all
other current assets and spontaneous liabilities will increase in proportion to sales. Using
a spreadsheet approach, but ignoring financing feedback effects, determine the additional
capital that you will need to raise.
*
A.
B.
C.
D.
E.
$2,075
$1,400
$1,625
$2,300
$1,850
Assets
2005
2005
Cash
Accounts Receivable
Inventories
$3,200
$1,800
$3,800
Accounts Payable
Accrued Wages
Notes Payable
$1,400
$600
$4,000
Page 20 of 57 Pages
$68,000
Long-Term Debt
Common Stock
Retained Earnings
$53,000
$6,400
$10,000
Total Assets
$76,800
$75,400
Assets
2004
2004
Current Assets
Fixed Assets
$1,200,000
$800,000
Accounts Payable
Accrued Wages
Notes Payable
Long-Term Debt
Total Common Equity
Total Assets
$2,000,000
$200,000
$200,000
$200,000
$600,000
$800,000
$2,000,000
Assume that in 2004, the company reported sales of $10 million, net income of $200,000,
and dividends of $120,000. Now assume that (1) the company anticipates its sales will
increase 20 percent in 2005, (2) its dividend payout will remain at 60 percent, and (3) the
company is at full capacity, and that all of its assets and spontaneous liabilities will
increase proportionately with an increase in sales.
Finally, assume the company uses the AFN formula and all additional funds needed (AFN)
will come from issuing new long-term debt. Given its forecast, and ignoring financing
feedback effects, determine how much long-term debt the company will need to issue in
2005.
*
A.
B.
C.
D.
E.
$224,000
$200,000
$216,000
$192,000
$208,000
Page 21 of 57 Pages
You are given below the 2004 year-end financial statements for your firm (in thousands)
and have been asked to project the firms funding needs for 2005. You may make the
following assumptions when making your forecast:
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
Sales are expected to increase by 30 percent over the coming year -- they will
increase to $19,500,000.
Operating costs are expected to decrease to 77 percent of sales.
The interest rate on long-term debt will remain at 10 percent for 2005, but the
interest rate on short-term debt, such as notes payable, will go up to 12 percent.
Taxes are expected to increase to 40 percent in 2005.
The firm expects to increase its dividend per share to $1.80 in 2005.
All current assets will increase proportionately with sales.
At the end of 2004, fixed assets (property plant and equipment) are being
operated at only 80 percent of capacity.
Fixed assets are lumpy. If the firm must increase its fixed assets, it will do so by
adding an amount equal to $1,500,000.
Accounts payable and accruals will increase proportionately with sales.
Notes payable will increase to $1,500,000 at the start of 2005.
Given this information, do a first pass and determine the firms additional funds needed
(AFN) for 2005.
Year: 2004
$15,000.00
$12,000.00
$3,000.00
$250.00
$2,750.00
$962.50
$1,787.50
$1,500.00
First Pass
Year: 2004
First Pass
$1,500.00
$4,500.00
$6,000.00
$12,000.00
$7,500.00
$19,500.00
Page 22 of 57 Pages
Accounts payable
Notes payable
Accruals
Total current liabilities
Long-term bonds
Total liabilities
Common stock (1 million shares)
Retained earnings
Total common equity
Total liabilities and equity
Additional Funds Needed
A.
B.
C.
D.
E.
$3,500.00
$1,000.00
$2,500.00
$7,000.00
$1,500.00
$8,500.00
$10,000.00
$1,000.00
$11,000.00
$19,500.00
$1,734.40
$2,276.00
$1,943.60
$2,107.00
$2,423.00
Year: 2004
$15,000.00
$12,000.00
$3,000.00
$250.00
$2,750.00
$962.50
$1,787.50
$1,500.00
First Pass
$19,500.00
$15,015.00
$4,485.00
$330.00
$4,155.00
$1,662.00
$2,493.00
$1,800.00
Year: 2004
First Pass
$1,500.00
$4,500.00
$6,000.00
$12,000.00
$7,500.00
$19,500.00
$1,950.00
$5,850.00
$7,800.00
$15,600.00
$9,000.00
$24,600.00
$3,500.00
$4,550.00
Page 23 of 57 Pages
Notes payable
Accruals
Total current liabilities
Long-term bonds
Total liabilities
Common stock (1 million shares)
Retained earnings
Total common equity
Total liabilities and equity
Additional Funds Needed
15.
$1,000.00
$2,500.00
$7,000.00
$1,500.00
$8,500.00
$10,000.00
$1,000.00
$11,000.00
$19,500.00
$1,500.00
$3,250.00
$9,300.00
$1,500.00
$10,800.00
$10,000.00
$1,693.00
$11,693.00
$22,493.00
$2,107.00
Assume that you are at your firms fiscal year end and that you have been given the
following information about the firm:
Sales this year = $2,000
Sales next year = $2,500
Sales increase projected for the coming year = 25 percent = $500
Net income this year = $250
Dividend payout rate (all years) = 50 percent
Current accounts payable = $500
Current accrued wages and taxes = $200
Also assume that, except for the accounts noted, there were no other current liabilities,
that all assets and spontaneous liabilities can be expressed as a percent of sales, that
the firms profit margin, dividend payout rate, etc., will remain constant over the coming
year, and that the firm has calculated that its additional funds needed over the coming
year will be $100. Given this information, and using the equation method, determine the
firms current level of total assets. (Hint: You are looking for A* in the equation. Profit
Margin is a function of Net Income.)
A.
B.
C.
D.
E.
$1,750.00
$1,725.00
$1,825.00
$1,775.00
$1,800.00
Page 24 of 57 Pages
Assume that you have done a first pass and have determined that your firms additional
funds needed for the coming year will $10,000. You have decided to meet this need by
issuing $6,000 of additional equity and $4,000 of long-term debt. You assume that
dividend payments will increase by $500 because of the additional shares sold, and that
the before-tax interest rate on the new debt will be 12 percent. Given this information,
and assuming that the firms tax rate is 40 percent, determine what the firms additional
funds needed will be if you now do a second pass and include these financing decisions.
A.
B.
C.
D.
E.
$740.00
$764.00
$788.00
$752.00
$776.00
Assume that your company would like to determine the growth rate in sales that will
allow it to expand as much as possible without having to issue external capital (that is, its
AFN will be equal to 0). Also assume that you have gathered the data listed below for
the firm. Given this information, and using the AFN formula, determine the maximum
growth rate of sales that the firm can sustain without having to issue external capital.
A.
B.
C.
D.
E.
5.27%
4.84%
5.63%
4.41%
6.02%
S = S1 - S0 = (S0) (g)
S1 = (S0) (1+g)
Where g = growth rate
AFN = 0 = (1.40)(S0)(g) - ($20,000 / $200,000) (S0)(g) - (S0)(1+g)(.08)(1-.25)
AFN = 0 = (1.40)(S0)(g) - (.10) (S0)(g) - (S0)(1)(.08)(1-.25) - (S0)(g)(.08)(1-.25)
AFN = 0 = (1.40)(S0)(g) - (.10) (S0)(g) - (S0)(.06) - (S0)(g)(.06)
(S0)(.06) = (1.40g)(S0) - (.10g)(S0) - (.06g)(S0) = (1.24g)(S0)
Page 25 of 57 Pages
.06 = (1.24)(g)
g = .06 / 1.24 = 4.8387097% = 4.84%
Proof:
S1 = ($200,000)(1.048387097) = $209,677.42
S = $9,677.42
AFN = (1.40)($9,677.42) - (.10)($9,677.40) - ($209,677.40)(.08)(1-.25)
AFN = $13,548.39 - $967.74 - $12,580.65 = $0.00
18.
You are given the following income statement and balance sheet:
Income Statement
Sales
$15,000
EBT
Taxes (40%)
$800
$320
Net Income
$480
Balance Sheet
Cash
A/R
Inventories
$100
$2,000
$4,000
Accounts Payable
Debt
Common Stock
$1,000
$4,000
$2,000
Total CA
Fixed Assets
$6,100
$1,900
Retained Earnings
$1,000
Total Assets
$8,000
Total Claims
$8,000
Using the equation method, determine the additional funds needed for the coming
year.
A.
B.
C.
$2,136.24
$2,012.43
$2,099.51
Page 26 of 57 Pages
D.
E.
$2,173.33
$2,045.86
2004
4,500.00
-3,825.00
675.00
-120.00
555.00
-123.34
431.66
-172.66
259.00
225.00
2004
Assets:
Cash
Accounts receivable
Inventories
Total current assets
Net plant and equipment
Total assets
450.00
375.00
675.00
1,500.00
1,080.00
2,580.00
562.50
783.40
225.00
1,570.90
450.00
2,020.90
400.00
159.10
559.10
2,580.00
2005 w/o
2005 w/
2005 w/o
2005 w/
AFN
Page 27 of 57 Pages
19.
Operating costs, current assets, accounts payable, and accruals will all
increase proportionately with sales.
Sales are expected to increase to $5,000 in 2005
The firm expects to add $200 to fixed assets. This increase will be depreciated
on a straight-line basis over 10 years. All other fixed assets will continue to be
depreciated at $120 per year.
The firm expects to pay off all of its notes payable at the beginning of 2005.
Long-term debt will continue to have an interest rate of 10 percent.
The firm plans to increase its total dividend to $250 in 2005.
Now, without considering how it is to be funded, do a first pass and determine the
additional funds needed.
A.
B.
C.
D.
E.
$794.28
$872.33
$833.57
$955.91
$904.45
Page 28 of 57 Pages
2004
4,500.00
-3,825.00
675.00
-120.00
555.00
-123.34
431.66
-172.66
259.00
225.00
2004
2005 w/o
5,000.00
-4,250.00
750.00
-140.00
610.00
-45.00
565.00
-226.00
339.00
250.00
2005 w/o
Assets:
Cash
Accounts receivable
Inventories
Total current assets
Net plant and equipment
Total assets
450.00
375.00
675.00
1,500.00
1,080.00
2,580.00
500.00
416.67
750.00
1,666.67
1,140.00
2,806.67
562.50
783.40
225.00
1,570.90
450.00
2,020.90
400.00
159.10
559.10
2,580.00
625.00
0.00
250.00
875.00
450.00
1,325.00
400.00
248.10
648.10
1,973.10
AFN
2005 w/
2005 w/
833.57
20.
Now assume that the firm plans to raise all of its additional funds needed as equity, but
that it will maintain dividends at $250. Do a second pass and determine the new level
of additional funds needed.
A.
B.
C.
D.
E.
$ 0.00
$100.00
$ 25.00
$ 75.00
$ 50.00
Page 29 of 57 Pages
2004
4,500.00
-3,825.00
675.00
-120.00
555.00
-123.34
431.66
-172.66
259.00
225.00
2004
2005 w/o
5,000.00
-4,250.00
750.00
-140.00
610.00
-45.00
565.00
-226.00
339.00
250.00
2005 w/o
2005 w/
5,000.00
-4,250.00
750.00
-140.00
610.00
-45.00
565.00
-226.00
339.00
250.00
2005 w/
Assets:
Cash
Accounts receivable
Inventories
Total current assets
Net plant and equipment
Total assets
450.00
375.00
675.00
1,500.00
1,080.00
2,580.00
500.00
416.67
750.00
1,666.67
1,140.00
2,806.67
500.00
416.67
750.00
1,666.67
1,140.00
2,806.67
562.50
783.40
225.00
1,570.90
450.00
2,020.90
400.00
159.10
559.10
2,580.00
625.00
0.00
250.00
875.00
450.00
1,325.00
400.00
248.10
648.10
1,973.10
625.00
0.00
250.00
875.00
450.00
1,325.00
1,233.57
248.10
1,481.67
2,806.67
833.57
0.00
AFN
No calculations are actually needed, since the only things that will cause AFN to be
different from zero on the second pass are financing feedback effects. Since the
dividend is maintained at $250, there are no feedback effects and the AFN will be
$0.00
21.
You are given below the 2005 year-end financial statements for your firm (in thousands)
and have been asked to project the firms funding needs for 2006. You may make the
following assumptions when making your forecast:
Page 30 of 57 Pages
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
Sales are expected to increase by 20 percent over the coming year -- they will
increase to $12,000,000.
Operating costs are expected to decrease to 75 percent of sales.
The interest rate on all debt will remain at 10 percent for 2006.
Taxes are expected to remain at 40 percent in 2006.
The firm expects to increase its dividend per share to $0.60 in 2006.
All current assets will increase proportionately with sales.
At the end of 2005, fixed assets (property plant and equipment) are being
operated at only 80 percent of capacity (you may ignore depreciation).
Fixed assets are lumpy. If the firm must increase its fixed assets, it will do so by
adding an amount equal to $2,500,000 (you may ignore depreciation).
Accounts payable and accruals will increase proportionately with sales.
Notes payable will decrease to $500,000 at the start of 2006.
Given this information, do a first pass and determine the firms additional funds needed
(AFN) for 2006.
Income Statement (In Thousands)
Year: 2005
Sales
$10,000.00
Operating costs
$ 8,000.00
$ 2,000.00
$
250.00
$ 1,750.00
Taxes
$ 1,050.00
Common dividends
First Pass
700.00
550.00
Year: 2005
First Pass
Assets:
Cash and marketable securities
$ 1,500.00
Accounts receivable
$ 4,500.00
Inventories
$ 6,000.00
$12,000.00
$ 7,500.00
Total assets
$19,500.00
$ 3,500.00
Notes payable
$ 1,000.00
Accruals
$ 2,500.00
$ 7,000.00
$ 1,500.00
Total liabilities
$ 8,500.00
Page 31 of 57 Pages
$10,000.00
Retained earnings
$ 1,000.00
$11,000.00
$19,500.00
A.
B.
C.
D.
E.
$690
$585
$655
$725
$620
Year: 2005
First Pass
Sales
$10,000.00
$12,000.00
Operating costs
$ 8,000.00
$ 9,000.00
$ 2,000.00
$ 3,000.00
250.00
200.00
$ 1,750.00
$ 2,800.00
Taxes
700.00
$ 1,120.00
$ 1,050.00
$ 1,680.00
Common dividends
550.00
Year: 2005
600.00
First Pass
Assets:
Cash and marketable securities
$ 1,500.00
$ 1,800.00
Accounts receivable
Inventories
$ 4,500.00
$ 6,000.00
$ 5,400.00
$ 7,200.00
$12,000.00
$14,400.00
$ 7,500.00
$ 7,500.00
Total assets
$19,500.00
$21,900.00
Accounts payable
$ 3,500.00
$ 4,200.00
Notes payable
Accruals
$ 1,000.00
$ 2,500.00
$ 500.00
$ 3,000.00
$ 7,000.00
$ 7,700.00
Long-term bonds
$ 1,500.00
$1,500.00
Total liabilities
$ 8,500.00
$9,200.00
$10,000.00
$ 1,000.00
$10,000.00
$2,080.00
Page 32 of 57 Pages
$11,000.00
$12,080.00
$19,500.00
$21,280.00
22.
$620.00
Assume that you wish to use the spreadsheet method to forecast additional funds
needed and have made the following assumptions:
Given this information, do a first pass and determine the amount of additional funds
needed for Year 1.
Income Statement
Year 0
Sales
Operating Costs
Depreciation
$5,000.00
-$3,000.00
-$ 600.00
EBIT
Interest
$1,400.00
-$ 185.00
EBT
Taxes (40%)
$1,215.00
-$ 486.00
Net Income
$ 729.00
$ 291.60
Assets
Year 0
Cash
Accounts Receivable
Inventories
$ 500.00
$1,500.00
$2,000.00
Year 1 (1st)
Year 1 (1st)
Page 33 of 57 Pages
Current Assets
Gross Plant & Equipment
Less: Depreciation
Net Plant & Equipment
Total Assets
$4,000.00
$6,000.00
-$2,400.00
$3,600.00
$7,600.00
Year 0
Accounts Payable
Notes Payable
Accruals
$1,250.00
$ 850.00
$ 500.00
Current Liabilities
Long-Term Debt
Common Stock
Retained Earnings
$2,600.00
$1,000.00
$3,500.00
$ 500.00
Year 1 (1st)
$7,600.00
A.
B.
C.
D.
E.
$515.00
$524.00
$518.00
$527.00
$521.00
Year 1 (1st)
Income Statement
Year 0
Sales
Operating Costs
Depreciation
$5,000.00
-$3,000.00
-$ 600.00
$6,500.00
-$3,770.00
-$ 600.00
EBIT
Interest
$1,400.00
-$ 185.00
$2,130.00
-$ 50.00
EBT
Taxes (40%)
$1,215.00
-$ 486.00
$2,080.00
-$ 832.00
Net Income
$ 729.00
$1,248.00
$ 291.60
$ 600.00
Year 1 (1st)
Assets
Year 0
Cash
Accounts Receivable
Inventories
$ 500.00
$1,500.00
$2,000.00
$ 400.00
$1,950.00
$2,600.00
Current Assets
Gross Plant & Equipment
$4,000.00
$6,000.00
$4,950.00
$6,000.00
Page 34 of 57 Pages
Less: Depreciation
Net Plant & Equipment
Total Assets
-$2,400.00
-$3,000.00
$3,600.00
$3,000.00
$7,600.00
$7,950.00
Year 1 (1st)
Year 0
Accounts Payable
Notes Payable
Accruals
$1,250.00
$ 850.00
$ 500.00
$1,625.00
$
0.00
$ 650.00
Current Liabilities
Long-Term Debt
Common Stock
Retained Earnings
$2,600.00
$1,000.00
$3,500.00
$ 500.00
$2,275.00
$ 500.00
$3,500.00
$1,148.00
$7,600.00
$7,423.00
$ 527.00
Year 0
Sales
Operating Costs
Depreciation
$5,000.00
-$3,000.00
-$600.00
EBIT
Interest
$1,400.00
-$185.00
EBT
Taxes (40%)
$1,215.00
-$486.00
Net Income
$729.00
$291.60
Assets
Year 0
Cash
Accounts Receivable
Inventories
$500.00
$1,500.00
$2,000.00
Current Assets
Gross Plant & Equipment
Less: Depreciation
Net Plant & Equipment
Total Assets
Year 1 (1st)
Year 1 (2nd)
Year 1 (1st)
Year 1 (2nd)
$4,000.00
$6,000.00
-$2,400.00
$3,600.00
$7,600.00
Page 35 of 57 Pages
Year 0
Accounts Payable
Notes Payable
Accruals
$1,250.00
$850.00
$500.00
Current Liabilities
Long-Term Debt
Common Stock
Retained Earnings
$2,600.00
$1,000.00
$3,500.00
$500.00
Year 1 (1st)
Year 1 (2nd)
$7,600.00
Assume that you wish to use the spreadsheet method to forecast additional funds
needed and have made the following assumptions:
Given this information, do a first pass and determine the amount of additional funds
needed for Year 1.
A.
B.
C.
D.
E.
$670.00
$650.00
$630.00
$660.00
$640.00
Income Statement
Year 0
Sales
Operating Costs
Depreciation
$5,000.00
-$3,000.00
-$600.00
Year 1 (1st)
Year 1 (2nd)
$6,000.00
-$3,900.00
-$700.00
Page 36 of 57 Pages
EBIT
Interest
$1,400.00
-$185.00
$1,400.00
-$200.00
EBT
Taxes (40%)
$1,215.00
-$486.00
$1,200.00
-$480.00
Net Income
$729.00
$720.00
$291.60
$350.00
Year 0
Cash
Accounts Receivable
Inventories
$500.00
$1,500.00
$2,000.00
$1,000.00
$1,800.00
$2,400.00
$4,000.00
$6,000.00
-$2,400.00
$5,200.00
$7,000.00
-$3,100.00
$3,600.00
$3,900.00
$7,600.00
$9,100.00
Current Assets
Gross Plant & Equipment
Less: Depreciation
Net Plant & Equipment
Total Assets
Year 0
Accounts Payable
Notes Payable
Accruals
$1,250.00
$850.00
$500.00
$1,500.00
$1,000.00
$600.00
Current Liabilities
Long-Term Debt
Common Stock
Retained Earnings
$2,600.00
$1,000.00
$3,500.00
$500.00
$3,100.00
$1,000.00
$3,500.00
$870.00
$7,600.00
$8,470.00
Year 1 (1st)
24.
Year 1 (1st)
Assets
Year 1 (2nd)
Year 1 (2nd)
$630.00
Assume that you intend to raise the additional funds needed (calculated above) by
issuing both long-term debt and new common stock (in the ratio of 50% debt and 50%
stock), and that this will cause your forecasted interest to increase to $224.40 (instead
of $200.00), and forecasted dividends to increase to $375.25 (instead of $350.00).
Given this information, determine the level of additional funds needed that will arise
from a second pass.
A.
B.
C.
D.
E.
$34.94
$42.43
$49.65
$28.16
$39.89
Page 37 of 57 Pages
The second pass AFN is due entirely to financing feedback effects. Interest has gone up
by $24.40, which will produce an offsetting tax shelter of $9.76, giving a net cost of debt
of $14.64, and dividends has increased by $25.25. This gives total financing feedback
of:
$14.64 + $25.25 = $39.89
A full forecast is, therefore, not required (you do not have to get #26 correct in order to
do #27), but one is given below to show that the above answer is correct.
Year 1 (1st)
Year 1 (2nd)
Income Statement
Year 0
Sales
Operating Costs
Depreciation
$5,000.00
-$3,000.00
-$600.00
$6,000.00
-$3,900.00
-$700.00
$6,000.00
-$3,900.00
-$700.00
EBIT
Interest
$1,400.00
-$185.00
$1,400.00
-$200.00
$1,400.00
-$224.40
EBT
Taxes (40%)
$1,215.00
-$486.00
$1,200.00
-$480.00
$1,175.60
-$470.24
Net Income
$729.00
$720.00
$705.36
$291.60
$350.00
$375.25
Year 1 (1st)
Year 1 (2nd)
Assets
Year 0
Cash
Accounts Receivable
Inventories
$500.00
$1,500.00
$2,000.00
$1,000.00
$1,800.00
$2,400.00
$1,000.00
$1,800.00
$2,400.00
$4,000.00
$6,000.00
-$2,400.00
$5,200.00
$7,000.00
-$3,100.00
$5,200.00
$7,000.00
-$3,100.00
$3,600.00
$3,900.00
$3,900.00
$7,600.00
$9,100.00
$9,100.00
Current Assets
Gross Plant & Equipment
Less: Depreciation
Net Plant & Equipment
Total Assets
Year 1 (1st)
Year 1 (2nd)
Year 0
Accounts Payable
Notes Payable
Accruals
$1,250.00
$850.00
$500.00
$1,500.00
$1,000.00
$600.00
$1,500.00
$1,000.00
$600.00
Current Liabilities
Long-Term Debt
Common Stock
Retained Earnings
$2,600.00
$1,000.00
$3,500.00
$500.00
$3,100.00
$1,000.00
$3,500.00
$870.00
$3,100.00
$1,315.00
$3,815.00
$830.11
$7,600.00
$8,470.00
$9,060.11
Page 38 of 57 Pages
25.
$630.00
$39.89
Assume that you are given the following historical relationship between a firms sales
and its level of inventory.
Year
Sales
Inventory
1
2
3
4
5
$3,875.24
$4,172.83
$4,783.29
$5,893.67
$7,231.91
$3,471.67
$3,685.94
$4,125.47
$4,924.94
$5,888.48
Based on this data, and using regression analysis, determine the level of safety stocks
that the firm appears to hold.
A.
B.
C.
D.
E.
$643.25
$675.10
$667.82
$681.50
$659.37
Input
Input
Input
Input
Input
3,471.67
3,685.94
4,125.47
4,924.94
5,888.48
+
+
+
+
+
Year 0
Sales
Operating Costs
$1,500.00
-$1,275.00
Depreciation
-$
EBIT
Interest
EBT
Taxes (40%)
Year 1 (1st)
Year 1 (2nd)
60.00
$ 165.00
-$
30.00
$ 135.00
-$
54.00
Page 39 of 57 Pages
Net Income
81.00
32.40
Assets
Year 0
Cash
Accounts Receivable
$ 20.00
$ 200.00
Inventories
$ 240.00
Current Assets
Gross Plant & Equipment
$ 460.00
$1,200.00
Less: Depreciation
Net Plant & Equipment
Total Assets
Year 1 (2nd)
Year 1 (1st)
Year 1 (2nd)
-$ 560.00
$ 640.00
$1,100.00
Year 0
Accounts Payable
Notes Payable
$ 150.00
$ 100.00
Accruals
$ 100.00
Current Liabilities
Long-Term Debt
Common Stock
$ 350.00
$ 200.00
$ 372.00
Retained Earnings
$ 178.00
Year 1 (1st)
$1,100.00
Assume that the firm expects sales to increase by 20 percent in Year 1, that total
assets, accounts payable, and accruals can be expressed as a percent of sales, and
that the firms profit margin and dividend payout rate will remain the same as in Year 0.
Based on this information, and using the equation method, determine the firms
additional funds needed for Year 1.
A.
B.
C.
D.
E.
$127.74
$119.36
$111.68
$123.81
$115.49
Page 40 of 57 Pages
Using a straight percent of sales forecasting method, you would forecast that inventories
would increase to $312.00 in Year 1 if sales increase by 30 percent ($240*1.30 = $312).
However, assume that the true relationship was determined by regression analysis to be
as follows:
Inventory = $112.50 + (0.085)(Sales)
Based on this information, determine the difference in inventory levels forecasted by
these two methods.
A.
B.
C.
D.
E.
$32.25
$35.25
$30.75
$29.25
$33.75
Assume that you wish to use the spreadsheet method to forecast additional funds
needed and have made the following assumptions:
Page 41 of 57 Pages
The firm has already announced that its total dividend to be paid out will be
increased by $7.00 in Year 1.
Given this information, do a first pass and determine the amount of additional funds
needed for Year 1.
A.
B.
C.
D.
E.
$74.00
$80.00
$77.00
$71.00
$83.00
Year 1 (1st)
Income Statement
Year 0
Sales
Operating Costs
$1,500.00
-$1,275.00
$1,800.00
-$1,476.00
Depreciation
-$
60.00
-$ 100.00
$ 165.00
$ 224.00
EBIT
Interest
EBT
-$
30.00
-$
$ 135.00
50.00
$ 174.00
Taxes (40%)
-$
54.00
Net Income
81.00
$ 104.40
32.40
Assets
Year 0
Cash
Accounts Receivable
$ 20.00
$ 200.00
$ 24.00
$ 240.00
Inventories
$ 240.00
$ 288.00
Current Assets
Gross Plant & Equipment
$ 460.00
$1,200.00
$ 552.00
$1,600.00
-$ 560.00
-$ 660.00
$ 640.00
$ 940.00
$1,100.00
$1,492.00
Less: Depreciation
Net Plant & Equipment
Total Assets
Year 1 (2nd)
-$
69.60
39.40
Year 1 (1st)
Year 1 (1st)
Year 0
Accounts Payable
Notes Payable
$ 150.00
$ 100.00
$ 180.00
$ 300.00
Accruals
$ 100.00
$ 120.00
Current Liabilities
Long-Term Debt
Common Stock
$ 350.00
$ 200.00
$ 372.00
$ 600.00
$ 200.00
$ 372.00
Year 1 (2nd)
Year 1 (2nd)
Page 42 of 57 Pages
Retained Earnings
Total Liabilities & Equity
$ 178.00
$ 243.00
$1,100.00
$1,415.00
77.00
Assume that you wish to use the spreadsheet method to forecast additional funds
needed and have made the same assumptions as in Question #28 to determine the
first-pass AFN for Year 1. Also assume now that the firm will raise these funds by
issuing stock and that this, in turn, will cause the firm to increase its total dividend to be
paid out to $41.75 in Year 1. Based on this information, determine what the additional
funds needed will be if you now do a second pass.
A.
B.
C.
D.
E.
$7.05
$3.95
$8.65
$2.35
$5.45
As discussed in class, the additional funds needed on a second pass will arise solely
from financing feedback effects. The only financing feedback is that total dividends to
be paid will increase by another $2.35, which will decrease the amount to be added to
retained earnings by the same amount. Therefore, the AFN for the second pass will
be $2.35 and no actual pass, first or second, is needed to solve the problem.
However, to show that the answer is correct, a first and second pass would look like
the following:
Year 1 (1st)
Year 1 (2nd)
Income Statement
Year 0
Sales
Operating Costs
$1,500.00
-$1,275.00
$1,800.00
-$1,476.00
$1,800.00
-$1,476.00
Depreciation
-$
60.00
-$ 100.00
-$ 100.00
$ 165.00
$ 224.00
$ 224.00
EBIT
Interest
EBT
-$
30.00
-$
$ 135.00
50.00
$ 174.00
-$
69.60
-$
50.00
$ 174.00
Taxes (40%)
-$
54.00
Net Income
81.00
$ 104.40
32.40
Assets
Year 0
Cash
Accounts Receivable
$ 20.00
$ 200.00
$ 24.00
$ 240.00
$ 24.00
$ 240.00
Inventories
$ 240.00
$ 288.00
$ 288.00
Current Assets
Gross Plant & Equipment
$ 460.00
$1,200.00
$ 552.00
$1,600.00
$ 552.00
$1,600.00
39.40
Year 1 (1st)
-$
69.60
$ 104.40
$41.75
Year 1 (2nd)
Page 43 of 57 Pages
Less: Depreciation
Net Plant & Equipment
Total Assets
-$ 560.00
-$ 660.00
-$ 660.00
$ 640.00
$ 940.00
$ 940.00
$1,100.00
$1,492.00
$1,492.00
Year 1 (1st)
Year 1 (2nd)
Year 0
Accounts Payable
Notes Payable
$ 150.00
$ 100.00
$ 180.00
$ 300.00
$ 180.00
$ 300.00
Accruals
$ 100.00
$ 120.00
$ 120.00
Current Liabilities
Long-Term Debt
Common Stock
$ 350.00
$ 200.00
$ 372.00
$ 600.00
$ 200.00
$ 372.00
$ 600.00
$ 200.00
$ 449.00
Retained Earnings
$ 178.00
$ 243.00
$ 240.65
$1,100.00
$1,415.00
$1,489.65
77.00
2.35
2006
2007 (1st)
2007 (2nd)
2007 (1st)
2007 (2nd)
$10,000.00
-$6,000.00
-$800.00
$3,200.00
-$400.00
$2,800.00
-$1,120.00
$1,680.00
$672.00
2006
$1,000.00
$3,000.00
$4,000.00
$8,000.00
$8,000.00
-$3,200.00
$4,800.00
$12,800.00
Page 44 of 57 Pages
2006
Accounts Payable
Notes Payable
Accruals
$2,500.00
$1,500.00
$1,000.00
Current Liabilities
Long-Term Debt
Common Stock
Retained Earnings
Total Liabilities & Equity
2007 (1st)
2007 (2nd)
$5,000.00
$2,500.00
$3,500.00
$1,800.00
$12,800.00
Using the equation method, and given the information above, calculate the additional
funds needed.
*
A.
B.
C.
D.
E.
$650.40
$458.40
$602.40
$554.40
$506.40
Page 45 of 57 Pages
2)
3)
4)
5)
6)
7)
8)
9)
10)
11)
Using the spreadsheet method, and given the information above, do a first pass and
calculate the additional funds needed, then do a second pass, assuming that all funds
are raised as notes payable, and determine the new level of additional funds needed.
A.
B.
C.
D.
E.
$71.64
$50.40
$64.57
$43.32
$57.48
Income Statement
Sales
Operating Costs
Depreciation
EBIT
Interest
EBT
Taxes (40%)
Net Income
Dividends Paid Out
2006
2007 (1st)
2007 (2nd)
$10,000.00
-$6,000.00
-$800.00
$3,200.00
-$400.00
$2,800.00
-$1,120.00
$1,680.00
$12,000.00
-$7,200.00
-$1,000.00
$3,800.00
-$350.00
$3,450.00
-$1,380.00
$2,070.00
$12,000.00
-$7,200.00
-$1,000.00
$3,800.00
-$445.80
$3,354.20
-$1,341.68
$2,012.52
$672.00
$828.00
$828.00
Assets
2006
Cash
Accounts Receivable
Inventories
Current Assets
Gross Plant & Equipment
$1,000.00
$3,000.00
$4,000.00
$8,000.00
$8,000.00
2007 (1st)
$1,000.00
$3,600.00
$4,800.00
$9,400.00
$10,000.00
2007 (2nd)
$1,000.00
$3,600.00
$4,800.00
$9,400.00
$10,000.00
Page 46 of 57 Pages
Less: Depreciation
Net Plant & Equipment
Total Assets
Liabilities & Equity
Accounts Payable
Notes Payable
Accruals
Current Liabilities
Long-Term Debt
Common Stock
Retained Earnings
Total Liabilities & Equity
-$3,200.00
$4,800.00
$12,800.00
2006
$2,500.00
$1,500.00
$1,000.00
$5,000.00
$2,500.00
$3,500.00
$1,800.00
$12,800.00
-$4,200.00
$5,800.00
$15,200.00
-$4,200.00
$5,800.00
$15,200.00
2007 (1st)
2007 (2nd)
$3,000.00
$1,000.00
$1,200.00
$5,200.00
$2,500.00
$3,500.00
$3,042.00
$14,242.00
$3,000.00
$1,958.00
$1,200.00
$6,158.00
$2,500.00
$3,500.00
$2,984.52
$15,142.52
$958.00
$57.48
As discussed in class, a second pass is not really needed, since any additional funds
needed will arise solely from financing feedback effects:
Original AFN = $958.00 = additional notes payable.
Interest Expense = ($958.00)*(0.10) = $95.80
After-tax Interest Expense = ($95.80)*(1-.40) = $57.48 = New AFN
32.
You are given the information listed below for your company. Now make the following
assumptions:
1)
2)
3)
4)
5)
6)
7)
8)
9)
10)
Page 47 of 57 Pages
11)
The firm has decided that any additional funds needed (AFN) will be raised as
notes payable at an interest rate of 10.0 percent.
Using the spreadsheet method, and given the information above, do a first pass and
calculate the additional funds needed, then do a second pass, assuming that all funds
are raised as notes payable, and determine the new level of additional funds needed.
Income Statement
Sales
Operating Costs
Depreciation
EBIT
Interest
EBT
Taxes (40%)
Net Income
2006
$1,000.00
Assets
2006
Cash
Accounts Receivable
Inventories
Current Assets
Gross Plant & Equipment
Less: Depreciation
$1,440.00
$4,320.00
$5,760.00
$11,520.00
$10,000.00
-$4,000.00
$6,000.00
$17,520.00
Accounts Payable
Notes Payable
Accruals
Current Liabilities
Long-Term Debt
Common Stock
Retained Earnings
Total Liabilities & Equity
2007 (2nd)
2007 (1st)
2007 (2nd)
2007 (1st)
2007 (2nd)
$14,400.00
-$8,640.00
-$1,000.00
$4,760.00
-$450.00
$4,310.00
-$1,724.00
$2,586.00
2007 (1st)
2006
$3,600.00
$2,000.00
$1,440.00
$7,040.00
$2,500.00
$3,500.00
$4,480.00
$17,520.00
$74.65
$77.65
$75.65
Page 48 of 57 Pages
D.
E.
$78.65
$76.65
Income Statement
2006
2007 (1st)
2007 (2nd)
Sales
Operating Costs
Depreciation
EBIT
Interest
$14,400.00
-$8,640.00
-$1,000.00
$4,760.00
-$450.00
$17,280.00
-$10,368.00
-$1,300.00
$5,612.00
-$350.00
$17,280.00
-$10,368.00
-$1,300.00
$5,612.00
-$481.08
EBT
Taxes (40%)
Net Income
$4,310.00
-$1,724.00
$2,586.00
$5,262.00
-$2,104.80
$3,157.20
$5,130.92
-$2,052.37
$3,078.55
$1,000.00
$1,200.00
$1,200.00
Assets
2006
Cash
Accounts Receivable
Inventories
Current Assets
Gross Plant & Equipment
Less: Depreciation
Net Plant & Equipment
Total Assets
Liabilities & Equity
Accounts Payable
Notes Payable
Accruals
Current Liabilities
Long-Term Debt
Common Stock
Retained Earnings
Total Liabilities & Equity
$1,440.00
$4,320.00
$5,760.00
$11,520.00
$10,000.00
-$4,000.00
$6,000.00
$17,520.00
2006
$3,600.00
$2,000.00
$1,440.00
$7,040.00
$2,500.00
$3,500.00
$4,480.00
$17,520.00
2007 (1st)
$1,000.00
$5,184.00
$6,912.00
$13,096.00
$13,000.00
-$5,300.00
$7,700.00
$20,796.00
2007 (1st)
2007 (2nd)
$1,000.00
$5,184.00
$6,912.00
$13,096.00
$13,000.00
-$5,300.00
$7,700.00
$20,796.00
2007 (2nd)
$4,320.00
$1,000.00
$1,728.00
$7,048.00
$2,500.00
$3,500.00
$6,437.20
$19,485.20
$4,320.00
$2,310.80
$1,728.00
$8,358.80
$2,500.00
$3,500.00
$6,358.55
$20,717.35
$1,310.80
$78.65
As discussed in class, a second pass is not really needed, since any additional funds
needed will arise solely from financing feedback effects:
Original AFN = $1,310.80 = additional notes payable.
Interest Expense = ($1,310.80)*(0.10) = $131.08
Page 49 of 57 Pages
33.
Assets
2007
2004
Current Assets
Fixed Assets
$2,400,000
$1,600,000
Accounts Payable
Accrued Wages
Notes Payable
Long-Term Debt
Total Common Equity
$600,000
$400,000
$200,000
$1,000,000
$1,800,000
Total Assets
$4,000,000
$4,000,000
Now assume that in 2007, the company reported sales of $20 million, net income of
$400,000, and dividends of $300,000. Also assume that (1) the company anticipates its
sales will increase 20 percent in 2008, (2) its dividend payout will remain at 75 percent,
and (3) the company is at full capacity, and that all of its assets and spontaneous liabilities
will increase proportionately with an increase in sales.
Finally, assume the company uses the AFN formula and all additional funds needed (AFN)
will come from issuing new long-term debt. Given its forecast, and ignoring financing
feedback effects, determine how much long-term debt the company will need to issue in
2008.
A.
B.
C.
D.
E.
$470,000
$500,000
$480.000
$510,000
$490,000
You are given below the 2007 year-end financial statements for your firm and have been
asked to project the firms funding needs for 2008. You may make the following
assumptions when making your forecast:
Page 50 of 57 Pages
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
Sales are expected to increase by 20 percent over the coming year -- they will
increase to $12,000,000.
Operating costs are expected to decrease to 58 percent of sales.
The interest rate on long-term debt will remain at 10 percent for 2008, but the
interest rate on short-term debt, such as notes payable, will go up to 12 percent.
The tax rate, currently 35 percent, is expected to increase to 40 percent in 2008.
The firm expects to maintain its dividend payout rate at 50 percent.
All current assets will increase proportionately with sales.
At the end of 2007, fixed assets (property plant and equipment) are being
operated at only 90 percent of capacity.
Fixed assets are lumpy. If the firm must increase its fixed assets, it will do so by
adding an amount equal to $2,000.
Currently, fixed assets are being depreciated on a straight-line basis over 10
years. Any new fixed assets will also be depreciated on a straight-line basis over
a 10-year period.
Accounts payable and accruals will increase proportionately with sales.
Notes payable will decrease to $2,000 at the start of 2008.
You should now be able to do a first pass and determine the firms additional funds
needed (AFN) for 2008. Now assume that the additional funds needed will be raised by
issuing new equity, but that the firm will not change its dividend payout rate (i.e., there
will be no financing feedback effects). Given this information, and considering the
issuance of new equity, determine what the firms return on equity (ROE) is forecasted to
be for 2008.
Income Statement
2007
Sales
Operating Costs
Depreciation
EBIT
Interest
EBT
Taxes (35%/40%)
Net Income
Dividends Paid Out
$10,000.00
-$6,000.00
-$1,200.00
$2,800.00
-$600.00
$2,200.00
-$770.00
$1,430.00
$715.00
Assets
2007
Cash
Accounts Receivable
Inventories
Current Assets
Gross Plant & Equipment
Less: Depreciation
Net Plant & Equipment
Total Assets
$1,000.00
$2,800.00
$4,000.00
$7,800.00
$12,000.00
-$4,800.00
$7,200.00
$15,000.00
2008 (1st)
$12,000.00
2008 (1st)
2008 (2nd)
$12,000.00
2008 (2nd)
Page 51 of 57 Pages
2007
$3,000.00
$4,000.00
$2,000.00
$9,000.00
$2,000.00
$3,500.00
$500.00
$15,000.00
2008 (1st)
2008 (2nd)
Income Statement
2007
2008 (1st)
2008 (2nd)
Sales
Operating Costs
Depreciation
EBIT
Interest
EBT
Taxes (35%/40%)
Net Income
Dividends Paid Out
$10,000.00
-$6,000.00
-$1,200.00
$2,800.00
-$600.00
$2,200.00
-$770.00
$1,430.00
$715.00
Assets
2007
Cash
Accounts Receivable
Inventories
Current Assets
Gross Plant & Equipment
Less: Depreciation
Net Plant & Equipment
Total Assets
$1,000.00
$2,800.00
$4,000.00
$7,800.00
$12,000.00
-$4,800.00
$7,200.00
$15,000.00
2007
A.
B.
C.
D.
E.
24.08%
26.82%
25.45%
29.56%
28.19%
Accounts Payable
Notes Payable
Accruals
Current Liabilities
$3,000.00
$4,000.00
$2,000.00
$9,000.00
$12,000.00
-$6,960.00
-$1,400.00
$3,640.00
-$440.00
$3,200.00
-$1,280.00
$1,920.00
$960.00
2008 (1st)
$1,200.00
$3,360.00
$4,800.00
$9,360.00
$14,000.00
-$6,200.00
$7,800.00
$17,160.00
2008 (1st)
$3,600.00
$2,000.00
$2,400.00
$8,000.00
$12,000.00
-$6,960.00
-$1,400.00
$3,640.00
-$440.00
$3,200.00
-$1,280.00
$1,920.00
$960.00
2008 (2nd)
$1,200.00
$3,360.00
$4,800.00
$9,360.00
$14,000.00
-$6,200.00
$7,800.00
$17,160.00
2008 (2nd)
$3,600.00
$2,000.00
$2,400.00
$8,000.00
Page 52 of 57 Pages
Long-Term Debt
Common Stock
Retained Earnings
Total Liabilities & Equity
Additional Funds Needed
$2,000.00
$3,500.00
$500.00
$15,000.00
$2,000.00
$3,500.00
$1,460.00
$14,960.00
$2,200.00
$2,000.00
$5,700.00
$1,460.00
$17,160.00
$0.00
35.
You are given the following financial statements for your company for Year 0:
Income Statement
Sales
Operating Costs
Depreciation
EBIT
Interest
EBT
Taxes (40%)
Net Income
Dividends Paid Out
Year 0
$8,000.00
-$4,800.00
-$600.00
$2,600.00
-$300.00
$2,300.00
-$920.00
Year 1 (1st)
Year 1 (2nd)
Year 1 (1st)
Year 1 (2nd)
Year 1 (1st)
Year 1 (2nd)
$1,380.00
$552.00
Assets
Year 0
Cash
Accounts Receivable
Inventories
Current Assets
Gross Plant & Equipment
Less: Depreciation
Net Plant & Equipment
Total Assets
$800.00
$2,400.00
$3,200.00
$6,400.00
$6,000.00
-$2,400.00
$3,600.00
$10,000.00
Year 0
Accounts Payable
Notes Payable
Accruals
Current Liabilities
Long-Term Debt
Common Stock
Retained Earnings
Total Liabilities & Equity
$2,000.00
$2,000.00
$800.00
$4,800.00
$1,000.00
$3,700.00
$500.00
$10,000.00
Page 53 of 57 Pages
Do a first pass to determine additional funds needed for Year 1. Then assume that the
additional funds needed will be raised in equal proportions of debt and equity. Do a
second pass and determine the new additional funds that will now be needed.
A.
B.
C.
D.
E.
$50.55
$56.13
$47.76
$53.34
$58.92
Income Statement
Sales
Operating Costs
Depreciation
EBIT
Interest
EBT
Taxes (40%)
Net Income
Dividends Paid Out
Assets
Cash
Accounts Receivable
Inventories
Current Assets
Year 0
$8,000.00
-$4,800.00
-$600.00
$2,600.00
-$300.00
$2,300.00
-$920.00
Year 1 (1st)
$10,400.00
-$6,240.00
-$900.00
$3,260.00
-$300.00
$2,960.00
-$1,184.00
Year 1 (2nd)
$10,400.00
-$6,240.00
-$900.00
$3,260.00
-$398.20
$2,861.80
-$1,144.72
$1,380.00
$1,776.00
$1,717.08
$552.00
$600.00
$600.00
Year 0
$800.00
$2,400.00
$3,200.00
$6,400.00
Year 1 (1st)
$1,000.00
$3,120.00
$4,160.00
$8,280.00
Year 1 (2nd)
$1,000.00
$3,120.00
$4,160.00
$8,280.00
Page 54 of 57 Pages
$6,000.00
-$2,400.00
$3,600.00
$10,000.00
Year 0
Accounts Payable
Notes Payable
Accruals
Current Liabilities
Long-Term Debt
Common Stock
Retained Earnings
Total Liabilities & Equity
$2,000.00
$2,000.00
$800.00
$4,800.00
$1,000.00
$3,700.00
$500.00
$10,000.00
$9,000.00
-$3,300.00
$5,700.00
$13,980.00
Year 1 (1st)
$9,000.00
-$3,300.00
$5,700.00
$13,980.00
Year 1 (2nd)
$2,600.00
$2,000.00
$1,040.00
$5,640.00
$1,000.00
$3,700.00
$1,676.00
$12,016.00
$2,600.00
$2,000.00
$1,040.00
$5,640.00
$1,982.00
$4,682.00
$1,617.08
$13,921.08
$1,964.00
$58.92
Alternatively, AFN on second pass co0me solely form financing feedback effects:
Additional Interest = ($982.00)*(0.10) = $98.20
After-tax Interest Cost = ($98.20)*(1-.40) = $58.92
36.
You are given the following financial statements for your company for Year 0:
Income Statement
Sales
Operating Costs
Depreciation
EBIT
Interest
EBT
Taxes (40%)
Net Income
Dividends Paid Out
Assets
Cash
Accounts Receivable
Inventories
Current Assets
Gross Plant & Equipment
Year 0
$7,000.00
-$4,200.00
-$600.00
$2,200.00
-$300.00
$1,900.00
-$760.00
Year 1 (1st)
Year 1 (2nd)
Year 1 (1st)
Year 1 (2nd)
$1,140.00
$456.00
Year 0
$700.00
$2,100.00
$2,800.00
$5,600.00
$6,000.00
Page 55 of 57 Pages
Less: Depreciation
Net Plant & Equipment
Total Assets
-$2,400.00
$3,600.00
$9,200.00
Year 0
Accounts Payable
Notes Payable
Accruals
Current Liabilities
Long-Term Debt
Common Stock
Retained Earnings
Total Liabilities & Equity
Year 1 (1st)
Year 1 (2nd)
$1,750.00
$2,000.00
$700.00
$4,450.00
$1,000.00
$3,300.00
$450.00
$9,200.00
Do a first pass to determine additional funds needed for Year 1. Then assume that the
additional funds needed will be raised in equal proportions of debt and equity. Do a
second pass and determine the new additional funds that will now be needed.
*
A.
B.
C.
D.
E.
$50.55
$56.13
$47.76
$53.34
$58.92
Income Statement
Sales
Operating Costs
Year 0
$7,000.00
-$4,200.00
Year 1 (1st)
$9,100.00
-$5,460.00
Year 1 (2nd)
$9,100.00
-$5,460.00
Page 56 of 57 Pages
Depreciation
EBIT
Interest
EBT
Taxes (40%)
-$600.00
$2,200.00
-$300.00
$1,900.00
-$760.00
-$900.00
$2,740.00
-$300.00
$2,440.00
-$976.00
-$900.00
$2,740.00
-$393.55
$2,346.45
-$938.58
Net Income
$1,140.00
$1,464.00
$1,407.87
$456.00
$600.00
$600.00
Year 0
Cash
Accounts Receivable
Inventories
Current Assets
Gross Plant & Equipment
Less: Depreciation
Net Plant & Equipment
Total Assets
$700.00
$2,100.00
$2,800.00
$5,600.00
$6,000.00
-$2,400.00
$3,600.00
$9,200.00
Year 0
Accounts Payable
Notes Payable
Accruals
Current Liabilities
Long-Term Debt
Common Stock
Retained Earnings
Total Liabilities & Equity
$1,750.00
$2,000.00
$700.00
$4,450.00
$1,000.00
$3,300.00
$450.00
$9,200.00
Year 1 (1st)
$1,000.00
$2,730.00
$3,640.00
$7,370.00
$9,000.00
-$3,300.00
$5,700.00
$13,070.00
Year 1 (1st)
Year 1 (2nd)
$1,000.00
$2,730.00
$3,640.00
$7,370.00
$9,000.00
-$3,300.00
$5,700.00
$13,070.00
Year 1 (2nd)
$2,275.00
$2,000.00
$910.00
$5,185.00
$1,000.00
$3,700.00
$1,314.00
$11,199.00
$2,275.00
$2,000.00
$910.00
$5,185.00
$1,935.50
$4,635.50
$1,257.87
$13,013.87
$1,871.00
$56.13
Alternatively, AFN on second pass co0me solely form financing feedback effects:
Additional Interest = ($935.50)*(0.10) = $93.55
After-tax Interest Cost = ($93.55)*(1-.40) = $56.13
Page 57 of 57 Pages