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LO6 – Implement a
parsimonious method for
multiyear forecasting of net 14, 15 23-25 23-25 8-10 7
operating profit and net
operating assets.
True/False
Answer: True
Rationale: Persistent activities are those that will recur – that is the point of forecasting, to predict
what will recur.
Answer: False
Rationale: The best forecasts are the most realistic ones. Being overly conservative can lead to
missed opportunities.
Answer: True
Rationale: Managers can use accruals to depress current period income by writing off an excessive
amount of assets and accruing an excessive amount of liabilities (big bath). Managers can also
increase current period income by accruing an insufficient allowance for uncollectible accounts, for
example.
Answer: False
Rationale: The adjusting process parses the financial statements into operating/nonoperating and
core/transitory components. It is useful for both historical and prospective analysis.
Answer: False
Rationale: The usual projection process begins with the income statement, followed by the balance
sheet, and finished with the statement of cash flows.
Answer: False
Rationale: The most accurate forecast of future revenue is one that considers future organic versus
M&A revenue growth. Historic numbers are informative to the extent that we expect past trends to
continue.
Answer: True
Rationale: Using units and prices allows the forecaster to alter each separately which is a more
dynamic and usually more accurate way to forecast demand and revenue.
Answer: False
Rationale: For accurate forecasts, we want to use the most stable and relevant ratios concerning the
company’s financial condition. Sometimes, the most recent ratios are not stable.
Answer: True
Rationale: We do not forecast disposals unless the MD&A specifically mentions them.
Answer: True
Rationale: Our forecasting process is to forecast a cash balance and adjust the level of investment
securities or short-term debt to balance the balance sheet.
Answer: False
Rationale: The statement of cash flow uses both to explain the change in cash on the balance sheet.
Answer: True
Rationale: Depreciation is a noncash expense that does not affect cash.
Answer: False
Rationale: Assumptions may vary for each year’s forecast.
Answer: False
Rationale: The parsimonious projection method relies on net operating asset turnover (NOAT) and
not total asset turnover (AT).
Answer: False
Rationale: The parsimonious projection method does not project individual income statement and
balance sheet items; it is used to project net operating profit (NOPAT) and net operating assets
(NOA).
Answer: B
Rationale: Companies often securitize (sell-off) their account receivables which removes the
receivables from the balance sheet, resulting in an increase in operating cash flows. Many analysts
consider this to be a financing, not an operating, activity.
Answer: B
Rationale: Distinguishing between organic and acquired income is important because acquired
growth is expensive. However, the acquired income should be considered for projection purposes as
long as the expenditures to acquire that income are included in the projections.
Answer: D
Rationale: All of these adjustments are legitimate, helpful adjustments.
Answer: A
Rationale: ($92 / $80) – 1 = 0.15 = 15%
NOPAT 397.3
NOA 2,884.6
Net operating profit margin (NOPM) 13.0%
Net operating asset turnover (NOAT) 1.06
A) $3,281.9 million
B) $3,455.0 million
C) $3,057.7 million
D) $3,178.4 million
E) None of the above
Answer: D
Rationale: $397.3 million / 13.0% = $3,056.1 million in revenue for 2013. 2014 projected revenue
would be $3,056.2 million x 1.04 = $3,178.4 million
A) $46,378.6 million
B) $48,215.6 million
C) $47,807.3 million
D) $55,563.6 million
E) None of the above
Answer: A
Rationale: $45,358 million × 1.0225 = $46,378.6 million
Answer: B
Rationale: $2,045 million ×1.05 × (($818 / $2,045) + 2%) = $902 million
Answer: D
Rationale: The most common approach to non-operating expenses is to assume that they do not
change from year to year.
Answer: E
Rationale: The tax expense will be a function of forecasted pre-tax income. Knowing the sales growth
rate is insufficient to determine pre-tax income because certain expenses may remain unchanged
from prior dollar levels.
Answer: C
Rationale: If initial balance sheet projection produces a high amount of short-term investments, the
company may decrease short or long-term debt if it exists.
Answer: E
Rationale: We do not know the proportion of 2013 sales spent on CAPEX that year, so we are unable
to determine the 2014 CAPEX.
Answer: B
Rationale: $8,729 / $126,761 = 6.9%.
$126,761 million × 1.03 = $130,564 million x 6.9% = $9,009 million
Cash $ 225,000
Marketable securities ?
Accounts receivable 680,000
Inventory 940,000
Non-current assets, net 1,420,000
Current liabilities 375,000
Total liabilities 1,060,000
Total equity 2,985,000
A) $0
B) $1,565,000
C) $780,000
D) $1,155,000
E) None of the above
Answer: C
Rationale: $780,000. Marketable securities is calculated as a plug value by subtracting assets from
projected total assets. Total assets equals total liabilities and equity.
Cash $ 110,000
Marketable securities ?
Accounts receivable 950,000
Inventory 875,000
Non-current assets, net 1,650,000
Total liabilities 1,525,000
Total equity 2,300,000
A) $0
B) $775,000
C) $650,000
D) $240,000
E) None of the above
Answer: D
Rationale: $240,000. Marketable securities is calculated as a plug value by subtracting assets from
projected total assets. Total assets equals total liabilities and equity.
Answer: A
Rationale: The company will need additional financing from debt or equity providers in the future in
order to support company growth.
Answer: C
Rationale: Unless operating assets are very significant and the company’s 10-K discusses anticipated
changes, the most common procedure is to assume nonoperating assets do not change.
2014 2013
Total revenue $320,000 $270,000
Property, plant, equipment, gross 25,000 21,000
Asset disposals 0 0
If revenue is projected to increase by 10% in 2015, projected 2015 capital expenditures would be:
A) $4,440
B) $4,000
C) $4,400
D) $0
E) None of the above
Answer: C
Rationale: 2014 CAPEX = 2014 PPE – 2013 PPE = $4,000 because there are no asset disposals.
Historical CAPEX rate = 2014 CAPEX / 2014 sales = 1.25%. Forecasted CAPEX = 2015 forecasted
revenue × 1.25% = $4,400
Answer: B and C
Rationale: A projected increase in current assets or a decrease in current liabilities results in a
projected cash outflow. Acquiring PPE is not an operating cash flow.
Answer: E
Rationale: Depreciation expense is calculated from historical average depreciation expense, not the
footnoted rates.
2014 2013
Total revenue $53,950 $50,745
Property, plant, equipment, gross 12,200 11,800
Property, plant, equipment, net 7,250 6,950
Depreciation expense 413 381
If revenue growth is projected to be 4.8%, the 2015 forecasted depreciation expense to be added
back on the statement of cash flows is:
A) $433 thousand
B) $427 thousand
C) $413 thousand
D) $519 thousand
E) None of the above
Answer: B
Rationale: Historical depreciation rate = $413 thousand (2014 depreciation expense) / $11,800
thousand (PPE, gross at end of 2013) = 3.50%. Depreciation expense is forecasted as PPE: $12,200
thousand (gross at end of 2014) × 3.50% = $427 thousand.
Answer: A
Rationale: $3,130 million × ($1,540 million / $2,981 million) = $1,617 million
Answer: A
Rationale: 2014 Sales × (1.07)3 = $1,102.5 million
Answer: E
Rationale: NOPAT and NOA are what parsimonious multiyear forecasting method predicts. The
required inputs are sales growth, net operating asset turnover (NOAT), and net operating profit
margin (NOPM). When we know all three, we can predict NOPAT and NOA.
2013
Total revenue (in millions) $126,761
Net operating profit margin (NOPM) 3.9%
Net operating asset turnover (NOAT) 2.7
A) $ 4,944 million
B) $ 5,141 million
C) $46,949 million
D) $48,826 million
E) None of the above
Answer: B
Rationale: $126,761 million × 1.04 × 0.039 = $5,141 million
2013
Total revenue (in millions) $126,761
Net operating profit margin (NOPM) 3.9%
Net operating asset turnover (NOAT) 2.7
A) $ 4,944 million
B) $ 5,141 million
C) $46,949 million
D) $48,826 million
E) None of the above
Answer: D
Rationale: $126,761 million × 1.04 / 2.7 = $48,826 million
Answer:
Sales are forecast as prior-year sales increased by the expected sales growth for the coming year.
We typically forecast cost of sales to be the same percentage as the prior year. Forecasted cost of
sales is forecasted sales multiplied by the prior-year cost of sales percentage. Inventory is typically
forecast as a constant percentage of sales. Tax expense is forecast using forecasted pretax income
and the same effective tax rate as in prior years.
Answer:
Net sales have been consistently declining. The sales growth rate from 2010 to 2011 was –2.1%,
from 2011 to 2012 was 1.5%, for 2012 to 2013 it was -2.8%, for 2013 to 2014 it was –2.4%. An
appropriate sales growth rate would be –2.4%, the rate from 2013 - 2014 or –1.5%, the average of
the four figures.
Answer:
Estimated growth rate = ($25,153 / $23,985) - 1 = 1.049 - 1= 4.9%.
2015 Sales = $25,153 ×1.049 = $26,385 million
2015 Cost of goods sold = $26,385 × (1 - 44.5%) = $14,644 million
Answer:
a. Total net revenue grew by 9.53% calculated as follows:
Product 2.43%
Service 14.04%
c. The 2014 and onward revenues could be separately projected and costs more closely projected to
match the growth in each related revenue. For example, costs and expenses associated with
Product could grow approximately 2.4%, whereas those associated with Service and other could
be projected to grow at 14.0%.
Answer:
a. In 2012, Kohl’s experienced a 2.5% increase in total sales.
b. The 2012 data show comparable store sales, organic growth, increased by an average of 0.3%.
c. Because sales growth at new stores impacted the overall growth so significantly, an analyst may
question Kohl’s ability to generate new sales from its existing stores, i.e. grow sales organically.
This is a concern because acquired growth is often more expensive than organic growth.
Answer:
($ in millions) 2014 2013 2012 2011 2010
Pretax income $2,850 $2,640 $2,700 $2,245 $2,526
Tax provision 923 $551 $878 $725 $810
Average tax rate 32.4% 20.9% 32.5% 32.3% 32.1%
An appropriate tax rate would be 32.3%. This is the company’s long-term average tax rate if we
ignore 2013. In 2013, the tax provision is comparatively low (20.9%) which is likely due to a one-time
item. The statutory rate is not appropriate because the company has not recorded taxes at that rate in
the past 5 years. More information from the tax footnote would help refine the tax rate to be used to
project 2015 financial information.
Answer:
2013 gross profit margin = 1 - ($102,978 / $126,761) = 18.8%.
2014 forecasted sales = $126,761 million × 1.03 = $130,564 million
2014 forecasted gross profit = $130,564 million × 0.188 = $24,546 million
Answer:
2015 forecasted sales = $1,086,550 × 98% = $1,064,819
2015 forecasted cost of sales = $1,064,819 × (1 – 28%) = $766,670
Sales $825.3
Cost of goods sold 570.7
Gross profit 254.6
Selling, general and administrative 202.2
R&D expenses 20.3
Other expenses, net 12.6
Operating profit 19.5
Interest expense 27.9
Loss before taxes ($8.4)
Project the 2015 income statement for Barrington Inc. assuming a 3% decrease in net sales and a
continuation of the 2014 gross profit margin and percentage relation to net sales for each of the other
expenses except for interest expense which will remain the same.
Answer:
Projected
($ in millions) Calculation 2015
Sales $825.3 × 0.97 $800.5
Cost of goods sold $800.5 × 0.692 553.9
Gross profit 246.6
Selling, general and administrative $800.5 × 0.245 196.1
R&D expenses $800.5 × 0.025 20.0
Other expenses, net $800.5 × 0.015 12.0
Operating profit 18.5
Interest expense No change 27.9
Loss before taxes ($9.4)
Project Arrow’s income statement assuming a 4% increase in sales, a 37% effective tax rate, and a
continuation of the 2014 percentage relation to net sales for expenses except for interest where the
company projects no change.
Answer:
Computation 2015
Total revenue $6,400,250 × 1.04 $6,656,260
Cost of revenue 46.6% 3,101,817
Gross profit 3,554,443
Selling and administrative expenses 29.3% 1,950,284
Operating income 1,604,159
Interest expense No change 263,900
Income before income taxes 1,340,259
Income tax expense 37% 495,896
Net income $844,363
2014
Total Revenue $100,640
Cost of Revenue 43,285
Gross Profit 57,355
Selling, General and Administrative Expenses 20,205
Other Expenses 6,870
Operating Income $ 30,280
Project 2015 operating income assuming a 2% decrease in sales. Assume that the 2014 percentage
relation of expenses to total revenue continue to hold in 2015.
Answer:
($ thousands) Computation 2015
Total Revenue $100,640 × 0.98 $98,627
Cost of Revenue $98,627 × 43.0% 42,410
Gross Profit 56,217
Selling, General and
Administrative Expenses $98,627 × 20.0% 19,725
Other Expenses $98,627 × 6.8% 6,707
Operating Income $ 29,785
Project accounts receivable, inventory, and accounts payable for 2014 given that sales are expected
to grow by 2% in 2014.
Answer:
Projected 2014 sales: $45,358 million x 1.02 = $46,265 million
Accounts receivable: 2014: $46,265 million × 0.129 = $5,968 million
Inventory: $46,265 million × 0.066 = $3,053 million
Accounts payable: $46,265 million × 0.031 = $1,434 million
Project accounts receivable, inventory, and accounts payable for 2014 given that sales are expected
to grow by 4% in 2014.
Answer:
Projected 2014 sales: $3,056.5 million x 1.04 = $3,178.8 million
Accounts receivable: 2014: $3,178.8 million × 0.174 = $553.1 million
Inventory: $3,178.8 million × 0.142= $451.4 million
Accounts payable: $3,178.8 million × 0.051 = $162.1 million
Answer:
a. 2014 cost of goods sold = $30,800 / 1.12 = $27,500 / 6.80 = 2014 Inventory = $4,044
b. Projected Inventory = Projected Cost of Goods Sold / Inventory Turnover rate = $30,800 / 6.80
= $4,529
a. Project 2014 capital expenditures (CAPEX) for property, plant and equipment assuming sales are
forecasted to grow at 5%.
b. What will be the forecasted amount for property, plant and equipment, gross, at the end of 2014?
c. What may be a more refined approach to projecting long-term assets?
Answer:
a. Projected CAPEX for 2014 = ($836 million / $45,358 million) = 1.8%;
($45,358 million x 1.05) = $47,626; $47,626 x 1.8% = $857 million
c. It is important to consider the components of property, plant and equipment and to separately
project CAPEX for each component. Also, we could refine our projections by identifying and
excluding any nonoperating assets. A company may hold property that is not being used for its
ongoing operations but rather for investment purposes (or any other purpose).
Cash $ 275,000
Marketable securities ??
Accounts receivable 440,000
Inventory 720,000
Non-current assets, net 1,250,000
Current liabilities 285,000
Total liabilities 900,000
Total equity 2,450,000
Answer:
$665,000: Marketable securities is calculated as a plug value by subtracting all other assets from
projected total assets. Total assets equals total liabilities and equity.
Cash 85,000
Marketable securities ?
Accounts receivable 520,000
Inventory 450,000
Non-current assets, net 1,100,000
Total liabilities 800,000
Total equity 1,850,000
Answer:
$495,000: Marketable securities is calculated as a plug value by subtracting all other assets from
projected total assets. Total assets equals total liabilities and equity.
Sales $95,362.8
Property plant and equipment, Dec. 31, 2014 $9,016.1
Property plant and equipment, Dec. 31, 2013 $6,741.7
2014 Depreciation expense / Property plant and
equipment, Dec. 31, 2013 7.6%
2014 Capital expenditures / 2014 Sales 1.8%
Project the company’s 2015 Sales, depreciation expense, and cash outflow to acquire new Property,
plant and equipment.
Answer:
Computation 2015 Projected
Sales $95,362.8 × 1.06 $101,084.6
Depreciation expense $9,016.1 × 7.6% $685.2
Cash for new PPE acquisitions $101,084.6 × 1.8% $1,819.5
a. Project 2015 capital expenditures (CAPEX) for property and equipment assuming sales are
forecasted to grow at 10%.
b. What will be the forecasted amount for property and equipment, gross, at the end of 2015?
c. What may be a more refined approach to projecting long-term assets?
Answer:
a. Projected CAPEX for 2015 = $187.5 million x 1.05 = $206.3 million 2015 sales; CAPEX 2014 /
Sales 2014 = 1.6%; $206.3 x 1.6% = $3.3 million
c. It is important to consider the components of the Property and equipment and to identify and
exclude any nonoperating assets. A company may hold property that is not being used for its
ongoing operations but rather for investment purposes (or any other purpose).
2013 2012
Sales $43,358 $47,182
Net earnings 2,981 2,745
Dividends paid 1,540 1,352
a. If you project sales for 2014 of $44,225 million and net earnings for 2014 of $3,140 million, what
dividends would you include in the projected 2014 statement of cash flows?
b. Explain where dividends would appear in the projected 2014 statement of cash flows.
Answer:
a. 2014 Net earnings × (2013 dividends / 2013 net earnings) = $1,622 million
b. Dividends are an outflow of cash reported in the financing activities section of the statement of
cash flows.
Sales $38,080
Net income 4,170
Dividends paid 556
Retained earnings 14,210
Answer:
a. 2015: $39,984 thousand; 2016: $41,983 thousand
Sales 5,045.4
Net income 627.5
Dividends paid 125.5
Retained earnings 9,284.3
Sales and net income are forecasted to grow by 6% per year for the next few years.
Answer:
a. 2015: $5,348.1 million; 2016: $5,669.0 million
Answer:
2014: $175,852.3 thousand × 0.13 = $22,861 thousand
2015: $175,852.3 thousand × 1.02 × 0.13 = $23,318 thousand
Answer:
$126,761 million × 1.08 × 0.039 = $5,339 million
Answer:
$126,761 × 1.08 / 2.7 = $50,704
Madison Inc.
Income statement for the year ended September 30, 2014
Sales $184,450
Cost of goods sold 95,584
Gross profit 88,866
Selling, general and administrative 40,030
Research and development expenses 10,132
Restructuring charge 2,852
Litigation settlement 12,500
Pension curtailment gain (340)
Other expenses, net 7,802
Total expenses 72,976
Operating profit 15,890
Interest expense 6,092
Gain on sale of long-term investments (3,257)
Income before taxes 13,055
Provision for income tax 5,106
Effect of change in accounting principle 8,231
Net loss $ (282)
Footnotes to Madison Inc.’s MD&A and financial statements disclose the following information:
1) Restructuring charges include accruals for severance packages and losses on asset write-downs.
The company does not anticipate further restructuring activity.
2) A lawsuit related to product malfunctions was settled and ongoing lawsuits will not materially
affect future income.
3) Changes to the company’s pension plan resulted in a one-time gain.
4) Securities were sold during the year to fund the litigation settlement.
5) Tax-law changes resulted in nondeductibility of certain expenses. The company anticipates a
37% tax rate for 2015 onward.
Required:
What adjustments would you make to Madison’s income statement before you started to forecast
earnings for 2015? Prepare an adjusted income statement.
Sales $184,450
Cost of goods sold 95,584
Gross profit 88,866
Selling, general and administrative 40,030
R&D expenses 10,132
Restructuring charge 0
Pension curtailment gain 0
Litigation settlement 0
Other expenses, net 7,802
Total expenses 57,964
Operating profit 30,902
Other expense (income)
Interest expense 6,092
Gain on sale of securities 0
Income before taxes 24,810
Provision for income tax (37%) 9,180
Effect of change in accounting principle 0
Net income $ 15,630
Snap-On Incorporated
Consolidated Balance Sheets
2013 2012
(in millions)
Cash and cash equivalents $ 217.6 $ 214.5
Trade and other accounts receivable-net 531.6 497.9
Finance receivables-net 374.6 323.1
Contract receivables-net 68.4 62.7
Inventories, net 434.4 404.2
Deferred income tax assets 85.4 81.8
Prepaid expenses and other assets 84.2 84.8
Total current assets 1,796.2 1,669.0
Property and equipment, net 392.5 375.2
Deferred income tax assets 57.1 110.4
Long-term finance receivables-net 560.6 494.6
Long-term contract receivables-net 217.1 194.4
Goodwill 838.8 807.4
Other intangibles, net 190.5 187.2
Other assets 57.2 64.1
Total assets $4,110.0 $3,902.3
Notes payable and current maturities of LT debt $ 113.1 $ 5.2
Accounts payable 155.6 142.5
Accrued benefits 48.1 50.6
Accrued compensation 95.5 88.3
Franchise deposits 59.4 54.7
Other accrued liabilities 243.7 247.9
Total current liabilities 715.4 589.2
Long-term debt 858.9 970.4
Deferred income tax liabilities 143.8 127.1
Retiree health care benefits 41.7 48.4
Pension liabilities 135.8 260.7
Other long-term liabilities 84.0 87.5
Total liabilities 1,979.6 2,083.3
Shareholders’ equity attributable to Snap-On Inc.
Common stock 67.4 67.4
Additional paid-in capital 225.1 204.6
Retained earnings 2,324.1 2,067.0
Accumulated other comprehensive loss (44.8) (124.2)
Treasury stock at cost (458.6) (412.7)
Total shareholders’ equity attributable to Snap-On Inc. 2,113.2 1,802.1
Noncontrolling interests 17.2 16.9
Total shareholders’ equity 2,130.4 1,819.0
Total liabilities and shareholders’ equity $4,110.0 $3,902.3
To forecast the financial statements, make the following assumptions. For accounts that are not
included in the list below, assume that the amount will not change for the forecasted year.
To forecast the financial statements, make the following assumptions. For accounts that are not
included in the list below, assume that the amount will not change for the forecasted year.
To forecast the financial statements, make the following assumptions. For accounts that are not
included in the list below, assume that the amount will not change for the forecasted year.
Growth in Net sales: Products 1.5%
Growth in Net sales: Services 3.0%
Cost of sales margin - Products 87.8%
Cost of sales margin - Services 88.8%
Goodwill impairment charge $0
Severances and other charges $0
Other nonoperating income $0
Income tax expense to earnings before tax 29.0%
Earnings from discontinued operations $0
Cash and cash equivalents to total net sales 5.8%
A/R to total net sales 12.9%
Inventories to Net sales: Products 8.3%
Depreciation expense to start of year PPE, net 21.2%
CAPEX to total net sales 1.8%
A/P to total net sales 3.1%
Customer advances to total net sales 14.0%
Salaries, benefits and payroll taxes to total net sales 4.0%
Accrued pension liabilities to total net sales 20.6%
Other postretirement benefit liabilities to total net sales 2.0%
Dividends to net earnings 51.7%
The following assumptions were used to develop the forecasted financial statements:
Snap-On Incorporated
Consolidated Balance Sheets
2014 2013
(in millions) (forecasted) (actual)
Cash and cash equivalents $ 225.7 $ 217.6
Marketable securities 131.3 --
Trade and other accounts receivable-net 553.1 531.6
Finance receivables-net 374.6 374.6
Contract receivables-net 68.4 68.4
Inventories, net 451.4 434.4
Deferred income tax assets 85.4 85.4
Prepaid expenses and other assets 84.2 84.2
Total current assets 1,974.1 1,796.2
Property and equipment, net 417.3 392.5
Deferred income tax assets 57.1 57.1
Long-term finance receivables-net 560.6 560.6
Long-term contract receivables-net 217.1 217.1
Goodwill 838.8 838.8
Other intangibles, net 164.6 190.5
Other assets 57.2 57.2
Total assets $4,286.8 $4,110.0
The following assumptions were used to develop the forecasted financial statements:
($ millions)
Net earnings $383.2
Adjustments to reconcile net earnings to net cash
provided (used) by operating activities:
Depreciation $392.5 × 12.3% 48.3
Amortization of other intangibles $190.5 × 13.6% 25.9
Changes in operating assets and liabilities, net of
effects of acquisitions:
Increase in receivables $553.1 - $531.6 (21.5)
Increase in inventories $451.4 - $434.4 (17.0)
Increase in accounts payable $162.1 - $155.6 6.5
Increase in accruals $254.3 - $243.7 10.6
Net cash provided by operating activities 436.0
NETFLIX, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands)
Year ended December 31, 2013 2012 2011
Revenues $4,374,562 $3,609,282 $3,204,577
Cost of revenues 3,083,256 2,625,866 2,039,901
Gross profit 1,291,306 983,416 1,164,676
Operating expenses:
Marketing 503,889 465,400 381,269
Technology and development 378,769 329,008 259,033
General and administrative 180,301 139,016 148,306
Total operating expenses 1,062,959 933,424 788,608
Operating income 228,347 49,992 376,068
Other income (expense):
Interest expense (29,142) (19,986) (20,025)
Interest and other
income(expense) (3,002) 474 3,479
Loss on extinguishment of
debt (25,129) - -
Income before income taxes 171,074 30,480 359,522
Provision for income taxes 58,671 13,328 133,396
Net income $ 112,403 $17,152 $ 226,126
(in thousands)
Operating expenses:
Technology and development 378,769 $4,812,018 × 8.7% 418,646 $5,293,220 × 8.7% 460,510
General and administrative 180,301 $4,812,018 × 4.1% 197,293 $5,293,220 × 4.1% 217,022
Provision for income taxes 58,671 $218,080 × 34.3% 74,801 $242,906 × 34.3% 83,385
Required:
a. Calculate net operating profit after tax (NOPAT) for 2013. Assume a statutory tax rate of 37.0%.
b. Calculate net operating assets for 2013.
c. Use the parsimonious method of forecasting to project net operating profit after tax (NOPAT) and
net operating assets (NOA) for 2014 and 2015. Assume that sales increase by 10% each year.
Assume that net operating profit margin (NOPM) and net operating asset turnover (NOAT) remain
unchanged from their 2013 levels.
c. Net operating profit margin (NOPM) = NOPAT / Sales = $4,921 / $126,761= 3.9%
Net operating asset turnover (NOA) = Sales / NOA = $126,761 / $47,163 = 2.69
Sales $ 3,056.5
Net operating profit after tax (NOPAT) 397.3
Operating assets 3,892.4
Operating liabilities 1,007.6
Assume that net operating profit margin (NOPM) and net operating asset turnover (NOAT) will remain
at 2013 levels. Assume that sales will grow as follows:
Required:
Use the parsimonious method of forecasting to project net operating profit after tax (NOPAT) and net
operating assets (NOA) for 2014 through 2017, inclusive.
Answer:
Operating assets $3,892.4
Operating liabilities 1,007.6
Net operating assets (NOA) $2,884.8
Sales $4,374,562
Net operating profit after tax (NOPAT) 148,485
Operating assets 4,212,158
Operating liabilities 3,579,002
Assume that net operating profit margin (NOPM) and net operating asset turnover (NOAT) will remain
at 2013 levels. Assume that sales will grow at 4% per year.
Required:
Use the parsimonious method of forecasting to project net operating profit after tax (NOPAT) and net
operating assets (NOA) for 2014 through 2017, inclusive.
Answer:
(in thousands).
Operating assets $4,212,158
Operating liabilities 3,579,002
Net operating assets (NOA) $ 633,156
Answer:
Management of earnings via accruals relates to the creation or using up of accrued liabilities or
reserves to shift earnings from one period into another. Under a “big bath” scenario, a company
reduces current earnings via excessive write-offs or accruals. Future periods’ earnings are increased
as a result of the reduction of depreciation expense, future write-offs of impaired assets or the
charging of future costs to liabilities rather than expense. Companies can also shift earnings into the
present by the underaccrual of liabilities or reserves. Since these must, eventually, be increased,
future periods’ earnings will be lower.
Answer:
If not misused, accruals generally increase the quality of earnings because accruals more accurately
reflect accounting transactions when they occur. Cash basis accounting is of lower quality. But if
misused, accruals can seriously undermine the quality of earnings.
One example of a quality-enhancing accrual is the impairment of assets. When an asset becomes
impaired, it is written off, even if it hasn’t been sold yet. By writing off the asset and recording the
loss, the impairment is being reported on a timelier basis.
Another example is the expected loss on uncollectible accounts. This is reported when the loss on
receivable is estimated, not when accounts are actually written off. This provides more timely
information.
A third example is accruing revenue – if a company earns income in a period, it should be recorded
even if the cash is not received. Depending on customer payments to determine when to record
revenue would create huge swings in net income that have no basis in economic reality.
Answer:
Expected macroeconomic activity: The retail industry is directly affected by the level of
disposable income of its customers and the population at large. In times of recession, consumers
choose to save their money rather than spend. Proper analysis of current economic activity
should be done in the case of Target to reflect overall economy growth and the expected growth
of retail sales. In contrast, if the economy is experiencing a spike in economic growth, one could
reasonably project an increase in sales greater than historical sales growth.
Competitive landscape: A company, as well as astute analysts, should always be aware of
competitive activity. New entrants to the category pose a major threat to the market share and
profitability of company. To accurately predict Target’s future performance, an analyst must
consider whether a capable adversary has entered the market place. Additionally, has Target’s
success forced out Kmart, Kohl’s or Sears stores in Target’s markets? Properly surveying such
changes to the competitive environment provides clues to a company’s market share, ability to
increase prices and ultimately sales growth, and should be taken into account when forecasting
future performance.
New versus old store mix: When Target opens a new store, the company experiences a huge
influx of sales during its first few months before revenue begins to even out. In contrast, old
outdated stores usually produce a proportionately lower level of sales. A super-chain, such as
Target, plans as many as 100 store openings globally every year. Accurate financial statement
projections must consider expansion plans and assimilate them accordingly into the company’s
forecast.
Answer:
Organic growth occurs when a company increases revenue by expanding product lines, or increasing
sales volume, or increasing sales price per unit, or all three. Organic growth generates additional
returns to existing assets with little new investment. Acquired growth, occurs when the company
acquires other companies or segments. This can allow a company to enter a new market quickly or to
acquire needed expertise, sometimes at a lower cost than would be required to develop internally.
Answer:
Model parameters that must be estimated in order to project future financial statements include:
Answer:
The level of projected cash is crucial to understanding how a company will finance itself in the future.
If an analyst projects negative cash levels, a company may have to finance that shortfall with
additional debt and/or equity capital. Conversely, if cash levels are projected to be positive, the
company will have excess cash to invest or funds with which it can retire debt or repurchase stock.
Answer:
The full projection method yields projected income statement, balance sheet and a statement of cash
flows. The parsimonious method yields only net operating profit and net operating assets. Thus, the
full method, while longer and more involved, provides much more detailed information and line items.
The full method is useful if the decision maker needs specific line item information, such as inventory
levels or cash needed to purchase new PPE. But if the only information required for a decision is the
level of profit in the coming years, or aggregate asset amounts, then the parsimonious method will
suffice.