Solution manual financial management 10e by keown chapter 04

CHAPTER Financial Forecasting, Planning, and Budgeting CHAPTER ORIENTATION This chapter is divided into two sections The first section includes an overview of the role played by forecasting in the firm's planning process The second section focuses on the construction of detailed financial plans, including developing a cash budget for future periods of the firm's operations A budget is a forecast of future events and provides the basis for taking corrective action and can also be used for performance evaluation The cash budget also provides the necessary information to estimate future financing requirements of the firm These estimates are the key elements in our discussion of financial planning and budgeting CHAPTER OUTLINE I Financial forecasting and planning A B The need for forecasting in financial management arises whenever the future financing needs of the firm are being estimated There are three basic steps involved in predicting financing requirements Project the firm's sales revenues and expenses over the planning period Estimate the levels of investment in current and fixed assets, which are necessary to support the projected sales level Determine the financing needs of the firm throughout the planning period The key ingredient in the firm's planning process is the sales forecast This forecast should reflect (l) any past trend in sales that is expected to continue and (2) the effects of any events, which are expected to have a material effect on the firm's sales during the forecast period 61 C II III The traditional problem faced in financial forecasting begins with the sales forecast and involves making forecasts of the impact of predicted sales on the firm's various expenses, assets, and liabilities One technique that can be used to make these forecasts is the percent of sales method The percent of sales method involves projecting the financial variable as a percent of projected sales As sales volume changes, the level of assets required to support the firm changes Assets are financed by liabilities and equity, so changes in assets lead to changes in liabilities and equity Current liabilities, such as accounts payable and accrued expenses, vary spontaneously as sales change Retained earnings are impacted by changes in net income and dividends The difference between the projected level of assets and the projected change in liabilities and equity is the discretionary financing needed Percent of sales forecasting can give erroneous results for assets that have scale economies or assets that must be purchased in discrete quantities Sustainable rate of growth A Sustainable rate of growth indicates how fast a firm can grow without having to increase the firm’s debt ratio and without having to sell more stock B Sustainable rate of growth, g = return on equity x (1 – dividend payout ratio) Financial planning and budgeting A Three functions of a budget are indicating the amount and timing of future financing needs, providing the basis for taking corrective action if actual figures not match budget estimates, and evaluating performance of the firm B The cash budget represents a detailed plan of future cash flows and can be broken down into four components: cash receipts, cash disbursements, net change in cash for the period, and new financing needed C Although no strict rules exist, as a general rule, the budget period shall be long enough to show the effect of management policies, yet short enough so that estimates can be made with reasonable accuracy For instance, the capital expenditure budget may be properly developed for a 10-year period while a cash budget may only cover 12 months 62 D Cash budgets can be used to develop a pro forma income statement and a pro forma balance sheet A pro forma income statement represents a statement of planned profit or loss for the future period and is based primarily on information generated in the cash budget The pro forma balance sheet for a future date is developed by adjusting present balance sheet figures for projected information found primarily within the cash budget and pro forma income statement ANSWERS TO END-OF-CHAPTER QUESTIONS 4-1 This rather simplistic forecast method assumes no other information is available which would indicate a change in the observed relationship between sales and the expense item, asset or liability being forecast Furthermore, the percent of sales method works best for projected sales levels that are very close to the base level sales used to determine the "percent of sales." The greater the difference in predicted and base level sales, in general, the less accurate will be the percent of sales forecast 4-2 In a fixed cash budget, cash flow estimates are made for a single set of sales estimates, whereas a variable budget involves the preparation of several cash flow estimates, with each estimate corresponding to a different set of sales estimates 4.3 A flexible (or variable) cash budget gives the firm's management more information regarding the range of possible financing needs of the firm, and secondly, it provides management with a standard against which it can measure the performance of those subordinates who are responsible for the various cost and revenue items contained in the budget 4-4 The probable effect on cash flows would be as follows: (a) increased cash inflow from sales but increased cash outflow to finance needed increases in inventories and other assets (b) increased supply of available cash (c) decreased cash inflow (d) immediate decrease in cash inflows (or a cash outflow) 4-5 As a general rule, the budget period should be long enough to show the effect of management policies yet short enough so that estimates can be made with reasonable accuracy Since some budgets, such as capital expenditure budgets, require long-range planning in order to be effective while other budgets are more effective for shorter periods, it would not be wise for a firm to establish a standard budget period for all budgets Instead, firms usually have a minimum of two and sometimes three types of budgets The short-term budget is very detailed and 63 includes a cash budget covering months to a year The intermediate term budget will contain pro forma statements and verbal descriptions of major investment/financing plans that cover to years A long-term plan would involve less detailed general statements about the firm's strategic plans covering the next to 10 years 4-6 A cash budget can also be used to determine the amount of excess cash on hand that will not be needed to finance future operations This excess cash can then be invested in securities or other profitable alternatives 4-7 The careful budgeting of cash is of particular importance to a seasonal operation because cash flows are not continuous The availability of cash resources must be carefully planned in order that the normal operation of the firm can be continued during slow periods In addition, it is important to plan for future cash needs so that excess funds may be invested SOLUTIONS TO END-OF-CHAPTER PROBLEMS Solutions to Problem Set A 4-1A Sales Net Income Current Assets Net fixed assets Total Assets 2003 12,000,000 1,200,000 % of Sales 2004 15,000,000 2,000,000 3,000,000 6,000,000 9,000,000 25% 50% 3,750,000 7,500,000 11,250,000 Accounts payable Long-term debt Total Liabilities 3,000,000 2,000,000 5,000,000 25% NA 3,750,000 2,000,000 5,750,000 Common stock Paid-in capital Retained earnings Common equity Total Liabilities and Equity 1,000,000 1,800,000 1,200,000 4,000,000 9,000,000 NA NA 1,000,000 1,800,000 3,200,000 6,000,000 11,750,000 Liabilities and Owner's Equity DFN = 64 (500,000) 4-2A a % Credit Sales 0.5 Sales February March April (estimated) 20,000 30,000 40,000 Accounts receivable (3/31/03) 20,000 plus credit sales for April (50% x 40,000) 20,000 less collections from Feb sales (50% x 20,000 x 5) (5,000) less collections from March sales(50% x 30,000 x 5)(7,500) Accounts receivable (4/30/03) 27,500 b Collections From: April cash sales February credit sales March credit sales $ 20,000 5,000 7,500 $ 32,500 4-3A Based upon the projections made, Sambonoza can expect to have total assets next year equal to $1.8 million made up of the $1 million in fixed assets plus $800,000 (.2 x $4 million) in current assets These assets will be financed by known sources of funding comprised of $900,000 in common equity [$800,000 + (.5)(.05)($4 million) = $900,000], plus payables and trade credit equal to 10% of projected sales ($400,000) which totals $1.3 million This leaves $500,000 ($1.8 million - $1.3 million), which will need to be raised to meet the financing needs of the firm 4-4A Instructor’s Note: This is an introductory percent of sales financial forecasting problem Students should be able to solve it after a first reading of the chapter (a) Projected Financing Needs = Projected Total Assets = Projected Current Assets + Projected Fixed Assets { x $20 m} +{ $5m + $.1m} = $11.77m = (b) DFN = Projected Current Assets + Projected Fixed Assets - Present LTD - Present Owner's Equity - [Projected Net Income - Dividends] - Spontaneous Financing { } + $5.1m - $2m - $6.5m - [.05 x $20m - $.5m] -{ x $20m} = x $20m DFN = $6.67m + $5.1m - $8.5m - $.5m - $2m = $.77m 65 (c) We first solve for the maximum level of sales for which DFN = 0: DFN = ( 1.5 - 05 ) Sales – (5.1M-2M-6.5M +.5M) 15 15 DFN = 1833 SALES - $2.9M = Thus, SALES = $15.82M The largest increase in sales that can occur without a need to raise "discretionary funds" is $15.82M - $15M = $820,000 4-5A Cash Accounts Receivable Inventories Net Fixed Assets $ 1m 1m 1.0m 8m $2.0m Current Liabilities Long-Term Debt Common Stock plus Retained earnings 66 $.6m 4m 1.0m $2.0m 4-6A (a) The Sharpe Corporation Cash Budget Worksheet Nov $220,000 67 Sales Collections: Month of sale (10%) First month (60%) Second month (30%) Total Collections Purchases Payments (one month lag) Cash Receipts (collections) Cash Disbursements Purchases Rent Other Expenditures Tax Deposits Interest on Short-Term Borrowing Total Disbursements Net Monthly Change Beginning Cash Balance Additional Financing Needed (Repayment) Ending Cash Balance Cumulative Borrowing (b) Dec $175,000 72,000 Jan $ 90,000 Feb $120,000 Mar $135,000 Apr $240,000 May $300,000 June $270,000 July $225,000 9,000 105,000 66,000 180,000 81,000 72,000 12,000 54,000 52,500 118,500 144,000 81,000 13,500 72,000 27,000 112,500 180,000 144,000 24,000 81,000 36,000 141,000 162,000 180,000 30,000 144,000 40,500 214,500 135,000 162,000 27,000 180,000 72,000 279,000 90,000 135,000 22,500 162,000 90,000 274,500 75,000 90,000 180,000 118,500 112,500 141,000 214,500 279,000 274,500 72,000 10,000 20,000 81,000 10,000 20,000 144,000 10,000 20,000 22,500 180,000 10,000 20,000 162,000 10,000 20,000 135,000 10,000 20,000 22,500 90,000 10,000 20,000 _ $102,000 $78,000 22,000 _ $111,000 $7,500 100,000 _ $196,500 ($84,000) 107,500 _ $210,000 ($69,000) 23,500 605 $192,605 $21,895 15,000 386 $187,886 $91,114 15,000 _ $120,000 $154,500 67,509 $100,000 _ $107,500 $ 23,500 60,500 $15,000 $ 60,500 (21,895) $ 15,000 $ 38,605 (38,605) $ 67,509 _ $222,009 The firm will have sufficient funds to cover the $200,000 note payable due in July In fact, if the firm's estimates are realized they will have $222,009 in cash by the end of July 4-7A Cash YES1 Marketable Securities NO Accounts Payable YES Notes Payable NO2 Plant and Equipment NO3 Inventories YES Cash receipts follow sales with a lag related to the payment habits of the firm's customers and the firm's policy regarding payments on its accounts payables Notes payable may well follow sales if the firm uses a line of credit to finance its working capital needs (discussed later in Chapter 18) The answer depends on whether or not the firm has excess capacity If there is excess capacity, plant and equipment will not vary directly with the level of firms sales If there is no excess capacity, plant and equipment will vary directly 4-8A (a) Current assets Net fixed assets x $80m = $16m x $80m = $ 8m $31m - $28m = $ 3m financing needs in 2004) (b) (c) $16m 15m $31m Accounts payable Notes payable3 Bonds payable Common equity $ 8m 3m 10m 10m $31m (Balancing figures which equal estimated discretionary = - - bonds = $31m - $8m - $10m - $10m = $3m See answer to question 4-1 Instructor’s Note: This problem follows the text example very closely and provides an excellent assigned exercise to accompany a first reading of the chapter 68 4-9A (a) Estimating Future Financing Needs Armadillo Dog Biscuit Co., Inc Projected Need for Discretionary Financing Current Assets Net Fixed Assets Total Present Level $2.0m $3.0m $5.0m % of Sales ($5m) = 40 or 40% = 60 or 60% Accounts Payable $.5m = 10 or 10% Accrued Expenses Notes Payable Current Liabilities Long-Term Debt Common Stock Retained Earnings Common Equity Total $.5m -$1.0m $2.0m 5m 1.5m $2.0m $5.0m = 10 or 10% - Projected Level (Based on $7m Sales) 40 x $7m = $ 2.8m 60 x $7m = $ 4.2m $ 7.0m 10 x 7m = 7m 10 x 7m = 7m Plug Figure = 1.11m $ 2.51m No Change $2.00m No Change 50m $1.5m + 07 x $7m = $ 1.99m $2.49m $ 7.00m Notes payable is a balancing figure which equals discretionary financing needed, DFN, which equals: Total Assets - Accounts Payable - Accrued Expenses - Long-Term Debt - Common Stock - Retained Earnings = $7.0m - $0.7m - $0.7m - $2.0m - $0.5m - $1.99m = $1.11m The projected retained earnings is the sum of the beginning balance of $1.5m plus net income for the period (.07 x $7m) (b) Current Ratio Debt Ratio Before = times = 60 or 60% After = 1.12 times = 644 or 64.4% The growth in the firm's assets (due to the projected increase in sales) was financed predominantly with notes payable (a current liability) This led to a substantial deterioration in both the firm's liquidity (as reflected in the current ratio) and an increase in its use of financial leverage 69 (c) The slower rate of growth in sales would have allowed Armadillo to finance a larger portion of the funds needed using retained earnings For example, using the percent net profit margin Armadillo would have 07 x $6m = $420,000 it could reinvest after one-year's operations plus 07 x $7 million = $490,000 from the second year's sales The total amount of retained earnings over the two years then would be $910,000 rather than only $490,000 as before This would mean that notes payable would be $380,000 after one year, and only $1.11m - 42m = $690,000 at the end of the second year The resulting level of current liabilities would be $2.09m Thus, the post sales growth current ratio after two years would be 1.34 ($2.8m/2.09m = 1.34) compared to 1.12 with a one-year growth period The debt ratio under the two-year growth period will be only 58% compared to approximately 64% with the single year growth period The slower growth pace would allow the firm to expand its assets more gradually, thus requiring less external financing since more earnings can be retained 4-10A Instructor’s Note: This problem differs from the text discussion of "discretionary financing needed" in that it relies on the projected change in assets rather than the projected level of total assets Under these circumstances DFN = TA - SL - RE where TA = the projected change in total assets, which is the amount of new financing needed (in total); SL = the projected change in spontaneous liabilities; and RE = the projected change in retained earnings that will be available to finance a portion of the firm's needs for new funds First, we estimate that the projected change in assets during the coming year will be: TA = 30 Sales = 30 ($500,000) = $150,000 Thus, total new financing of $150,000 must be obtained during the next year to support the growth in firm sales Next, we project the change in spontaneous liabilities (SL) SL = 15 Sales = 15 ($500,000) = $75,000 Finally, we project new retained earnings (RE) that will be available to help finance the firm's operations during the next year, RE = New Income - Dividends RE = = = 05 x Projected Sales - 04 x Projected Sales 01 ($5,500,000) $55,000 70 We can make a forecast of inventories using the relationship observed between sales and inventories in part a by sketching a line through the observed relationship and extrapolating the line to sales of $30,000,000 Inventory ( In Thousands) 1,500 1,400 1,300 1,200 1,100 1,000 10,000 15,000 20,000 25,000 30,000 35,000 Sales (In Thousands) Using this graphical technique we see that the level of inventories will probably be just over $1,300,000 The substantial difference in the percent of sales forecast and the "true relationship" forecast is a result of the implicit assumption made when using the percent of sales forecast That is, the percent of sales forecast is simply a linear extrapolation of inventories based on sales where the intercept is assumed to be zero As we saw in part a, above, this assumption is not valid for this problem 80 SOLUTION TO INTEGRATIVE PROBLEM Historical data for Phillips Petroleum: 1986-92 Sales Net Income Earnings per share Dividends per share Number of Common Shares 78 Current Assets Total Assets Current Liabilities Long-term Liabilities Total Liabilities Preferred Stock Common Equity Total Liabilities and Equity Projected Sales 1986 10,018 228 0.89 2.02 1987 10,917 35 0.06 1.73 1988 11,490 650 2.72 1.34 1989 12,492 219 0.90 0.00 1990 13,975 541 2.18 1.03 1991 13,259 98 0.38 1.12 1992 12,140 270 1.04 1.12 259,615,385 2,802 12,403 2,234 8,175 10,409 270 1,724 12,403 2,855 12,111 2,402 7,887 10,289 205 1,617 12,111 3,062 11,968 2,468 7,387 9,855 2,113 11,968 2,876 11,256 2,706 6,418 9,124 2,132 11,256 3,322 12,130 2,910 6,501 9,411 2,719 12,130 1993 3,000 1994 3,500 1995 4,000 1996 4,500 1997 5,500 2,459 11,473 2,603 6,113 8,716 2,757 11,473 2,349 11,468 2,517 5,894 8,411 359 2,698 11,468 Projected Net Income using the percent of sales method Sales Net Income Net Income/Sales Average Net Income/Sales Projected Sales Projected Net Income 1986 10,0 18 28 2.28% 2.406% 1993 13,0 00 13 1987 10,9 17 35 0.32% 1988 11,4 90 50 5.66% 1989 12,4 92 19 1.75% 1990 13,9 75 41 3.87% 1994 13,5 00 25 1995 14,0 00 37 1996 14,5 00 49 1997 15,5 00 73 1991 13,2 59 98 0.74% 1992 12,1 40 70 2.22% Projected total assets and current liabilities 79 Sales Total Assets Current Liabilities TA/Sales CL/Sales Average TA/Sales Average CL/Sales 1986 10,0 18 12,4 03 2,2 34 1987 10,9 17 12,1 11 2,4 02 1988 11,4 90 11,9 68 2,4 68 1989 12,4 92 11,2 56 2,7 06 1990 13,9 75 12,1 30 2,9 10 1991 13,259 1992 12,140 11,473 11,468 2,603 2,517 123.81% 22.30% 110.94% 22.00% 104.16% 21.48% 90.11% 21.66% 86.80% 20.82% 86.53% 19.63% 94.46% 20.73% 99.54% 21.23% Projected Sales Projected Total Assets Projected C Liabilities 1993 13,0 00 12,9 40 2,7 60 1994 13,5 00 13,4 38 2,8 66 1995 14,0 00 13,9 36 2,9 72 83 1996 14,5 00 14,4 33 3,0 78 1997 15,5 00 15,4 29 3,2 91 Projected discretionary financing requirements for 1993-97 Total Assets Current Liabilities Long-term Debt Preferred Stock Common Equity* Discretionary Financing Needed** 1993 12,9 40 1994 13,4 38 1995 13,9 36 1996 14,4 33 1997 15,42 2,7 60 5,8 94 59 2,7 20 2,8 66 5,8 94 59 2,7 54 2,9 72 5,8 94 59 2,8 00 3,0 78 5,8 94 59 2,8 58 3,29 5,89 35 2,94 1,2 07 1,5 65 1,9 11 2,2 44 2,94 * Common dividends = $1.12 x the number of common shares outstanding in 1992 ( 259,615,385) Thus, Common Equity (1993) = Common Equity (1992) + NI (1993) - Dividends (1993) 80 ** Discretionary Financing Needed = Projected Total Assets - Current Liabilities - Long-term Debt - Preferred Stock - Common Equity Solutions to Problem Set B 4-1B Sales Net Income 2003 20,000,000 1,000,000 Current Assets Net fixed assets Total Assets 4,000,000 8,000,000 12,000,000 Liabilities and Owner's Equity Accounts payable 3,000,000 Long-term debt 2,000,000 Total Liabilities 5,000,000 Common stock 1,000,000 Paid-in capital 1,800,000 Retained earnings 4,200,000 Common equity 7,000,000 Total Liabilities and Equity12,000,000 % of Sales 20% 40% 5,000,000 10,000,000 15,000,000 15% NA 3,750,000 2,000,000 5,750,000 1,000,000 1,800,000 6,200,000 9,000,000 14,750,000 NA NA DFN = 4-2B a b % Credit Sales 2004 25,000,000 2,000,000 250,000 40% Sales February March April (estimated) 100,000 80,000 60,000 Accounts receivable (3/31/04) plus credit sales (April) less coll from February less coll from March Accounts receivable (4/30/04) 52,000 24,000 (20,000) (16,000) 40,000 Cash Sales Collections from February Collections from March Realized Cash during April 36,000 20,000 16,000 72,000 4-3B Based upon the projections made, Simpson can expect to have total assets next year equal to $1.75 million made up of the $1 million in fixed assets plus $.75 million in current assets (.15 x 5m) These assets will be financed by known sources of funding comprised of the firm's common equity, 85million ($.7 million + $.3 million - $.15 million) plus payables and trade credit equal to 11% of projected sales ($.55 million) which totals $1.4 million This leaves $.35 million, which will need to be raised to meet the financing needs of the firm 81 4-4B Instructor’s Note: This is an introductory percent of sales financial forecasting problem Students should be able to solve it after a first reading of the chapter (a) Projected Financing Needs = Projected Total Assets = Projected Current Assets + Projected Fixed Assets =( x 25m) + 6m + 1m 18 = $15,822,222 (b) DFN = Projected Current Assets + Projected Fixed Assets - Present LTD - Present Owner's Equity - [Projected Net Income - Dividends] - Spontaneous Financing =( 1.5 x 25m) + 6m + 1m – 2m –9.5m – (.05 x 25m - 6m) – ( x 25m) 18 18 DFN = $1,588,889 (c) We first solve for the maximum level of sales where DFN = 0: DFN = ( 1.5 -.05 ) Sales + 6.1m –2m –9.5m +.6m 18 18 = 25556 Sales -4.8 million = Thus, SALES = $18,782,282 The largest increase in sales that can occur without a need to raise "discretionary funds" is $18,782,282 - $18m = $782,282 4-5B Cash Accounts Receivable Inventories Net Fixed Assets $ 03m 14m 1.0m 83m $2.0m Current Liabilities Long-Term Debt Common Equity $.39m 81m 80m $2.0m 4-6B (a) CASH BUDGET DATA January February March April 100,000 110,000 130,000 250,000 May June July August 82 275,000 250,000 235,000 160,000 The Carmel Corporation Cash Budget Worksheet Nov Dec $220,000 $175,000 Collections: Month of sale (20%) First month (60%) Second month (20%) Total Collections Purchases 70,000 Payments (1 mo lag) Cash Receipts (collections) 83 Cash Disbursements Purchases Rent Other Expenditures Tax Deposits Interest on Short-Term Borrowing Total Disbursements Net Monthly Change Beginning Cash Balance Additional Financing Needed (Repayment) Ending Cash Balance Cumulative Borrowing (b) 77,000 70,000 Jan $100,000 Feb $110,000 Mar $130,000 Apr $250,000 May $275,000 June $250,000 July $235,000 20,000 105,000 44,000 169,000 91,000 77,000 22,000 60,000 35,000 117,000 175,000 91,000 26,000 66,000 20,000 112,000 192,500 175,000 50,000 78,000 22,000 150,000 175,000 192,500 55,000 150,000 26,000 231,000 164,500 175,000 50,000 165,000 50,000 265,000 112,000 164,500 47,000 150,000 55,000 252,000 112,000 169,000 117,000 112,000 150,000 231,000 265,000 252,000 77,000 10,000 20,000 91,000 10,000 20,000 175,000 10,000 20,000 23,000 192,500 10,000 20,000 175,000 10,000 20,000 112,000 10,000 20,000 560 1,291 164,500 10,000 20,000 23,000 1,044 $223,060 ($73,060) 20,000 73,060 $206,291 $24,709 20,000 (24,709) $218,544 $46,456 20,000 (46,456) $142,579 $109,421 20,000 (57,895) $20,000 $129,060 $20,000 $104,351 $ 20,000 $57,895 $71,526 $107,000 $62,000 22,000 $84,000 $121,000 $228,000 ($4,000) ($116,000) 84,000 80,000 56,000 $80,000 $20,000 56,000 The firm will not have sufficient funds to cover the $250,000 note payable due in July 579 Aug 160k 4-7B Cash Marketable Securities Accounts Payable Notes Payable Plant and Equipment Inventories 4-8B (a) YES NO YES NO NO1 YES The answer depends on whether or not the firm has excess capacity If there is excess capacity, plant and equipment will not vary directly with the level of firms sales If there is no excess capacity, plant and equipment will vary directly $13.33m 1.67m 10.00m 10.00m $35.00m (b) Total financing requirements = $35m however, spontaneous financing accounts for all but the $1.67m increase in notes payable (discretionary financing needed) (c) See answer to question 4-1 4-9B Instructor’s Note: This problem follows the text example very closely and provides an excellent assigned exercise to accompany a first reading of the chapter (a) Current assets Net fixed assets $20.00m 15.00m $35.00m Accounts payable Notes payable Bonds payable Common equity Estimating Future Financing Needs Symbolic Logic Corporation (SLC), Inc Projected Need for Discretionary Financing Current Assets Net Fixed Assets Total Assets Accounts Payable Accrued Expenses Notes Payable* Present Level $2.5m $3.0m $5.5m $.1.0m $.5m Current Liabilities $1.50m Long-Term Debt $2.00m Common Stock 50m Retained Earnings** 1.50m Common Equity $2.00m Total Liabilities and Equity % of Sales ($5m) = 50% = 60% = 20% = 10% - Projected Level (Based on $8m Sales) 50 x $8m = $ 4.0m 60 x 8m = $ 4.80m $ 8.80m 20 x 8m = 1.60m 10 x 8m = 80m Plug Figure 1.84m $ 4.24m No Change $2.00m No Change 50m $1.5m + (07 x $8m) = $ 2.06m $2.56m $5.50m $8.80m *Notes payable is a balancing figure which equals discretionary financing needed, DFN or: Total Assets - Accounts Payable - Accrued Expenses - Long-Term Debt Common Stock - Retained Earnings = $8.80m - 1.60m - 8m – 2m - 5m – 2.06m = $1.84m 84 **The projected level of retained earnings equals the beginning balance of $1.50m plus net income for the period (.07 x $8m) (b) Before After Current Ratio = 1.67 times = 94 times Debt Ratio = 64% = 71% The growth in the firm's assets (due to the projected increase in sales) was financed predominantly with notes payable (a current liability) This led to a substantial deterioration in the firm's liquidity (as reflected in the current ratio) and an increase in its use of financial leverage (c) The slower rate of growth in sales would have allowed SLC to finance a larger portion of the funds needed using retained earnings 4-10B.Instructor’s Note: This problem differs from the text discussion of "discretionary financing needed" in that it relies on the projected change in assets rather than the projected level of total assets Under these circumstances DFN = TA - SL - RE where TA = the projected change in total assets, which is the amount of new financing needed (in total); SL = the projected change in spontaneous liabilities; and RE = the projected change in retained earnings that will be available to finance a portion of the firm's needs for new funds First, we estimate that the projected change in assets during the coming year will be: TA = = 40 Sales 40 ($500,000) = $200,000 Thus, total new financing of $200,000 must be obtained from somewhere during the next year to support the growth in firm sales Next, we project the change in spontaneous liabilities (SL) SL = = 15 x Sales 15 ($500,000) = $75,000 Finally, we project new retained earnings (RE) that will be available to help finance the firm's operations during the next year, RE RE = = = = New Income - Dividends 05 x Projected Sales - 04 x Projected Sales 01 ($5,500,000) $55,000 Discretionary Financing Needed (DFN) can now be calculated as follows: DFN = = = TA - SL - RE $200,000 - 75,000 - 55,000 $70,000 Note that this problem solution works with the change in financing needs rather than totals The same solution would result if we projected total assets, total spontaneous financing, etc However, in this problem we not know the existing levels of the assets, liabilities and owners' equity accounts Thus, we cannot use this latter approach to solve this problem 85 4-11B Minimum Cash Balance Beginning Cash Balance = = 25,000 28,000 Historical Sales and Base Case Sales Predictions for Future Sales January 120,000 May February 160,000 June March 140,000 July April 190,000 August Sales Expansion % = 0.00% Purchases as a % Sales = 75% Collections: Current Mo 30% 86 225,000 250,000 200,000 220,000 Annual Interest Rate = 12.00% Mo Later Mo Later 30% 40% Cash Budget for January thru July based on expected sales Nov Dec Jan Feb Sales 230,000 225,000 120,000 160,000 Collections: Month of sales 36,000 48,000 First month 67,500 36,000 Second month 92,000 90,000 Total Collections 195,500 174,000 Purchases 90,000 120,000 105,000 142,500 Payments 90,000 120,000 105,000 Cash Receipts 195,500 174,000 (collections) 87 Cash Disbursements Payments for Purchases Rent Other Expenditures Tax Deposits Interest on Short-Term Borrowing Total Disbursements 120,000 12,000 20,000 105,000 12,000 20,000 Mar 140,000 Apr 190,000 May 225,000 June 250,000 July 210,000 42,000 48,000 48,000 138,000 168,750 142,500 138,000 57,000 42,000 64,000 163,000 187,500 168,750 163,000 67,500 57,000 56,000 180,500 157,500 187,500 180,500 75,000 67,500 76,000 218,500 165,000 157,500 218,500 63,000 75,000 90,000 228,000 142,500 12,000 20,000 26,500 168,750 12,000 20,000 187,500 12,000 20,000 157,500 12,000 20,000 26,500 564 165,000 12,000 20,000 $152,000 Net Monthly Change $43,500 Analysis of Borrowing Needs Beginning Cash Balance Ending Cash (No Borrow) Needed (Borrowing) Loan Repayment Ending Cash Balance Cumulative Borrowing 28,000 71,500 0 $71,500 $137,000 173 545 $201,000 $200,750 $219,673 $216,564 $197,545 $37,000 ($63,000) ($37,750) ($39,173) 71,500 108,500 0 $108,500 165,000 228,000 108,500 45,500 0 $45,500 45,500 7,750 17,250 $25,000 $17,250 $1,936 $30,455 25,000 25,000 (14,173) 26,936 39,173 0 1,936 $25,000 $ 25,000 $56,423 $54,487 25,000 55,455 30,455 $25,000 24,032 August 220,000 Cash Budget for January thru July based on a 20% increase in sales Nov Dec Jan Feb Mar Apr Sales 230,000 225,000 144,000 192,000 168,000 228,000 Collections: Month of sales 43,200 57,600 50,400 68,400 First month 67,500 43,200 57,600 50,400 Second month 92,000 90,000 57,600 76,800 Total Collections 202,700 190,800 165,600 195,600 Purchases 108,000 Payments Cash Receipts (collections) 144,000 108,000 88 Cash Disbursements Payments for Purchases Rent Other Expenditures Tax Deposits Interest on Short-Term Borrowing Total Disbursements May 270,000 June 300,000 July 252,000 81,000 68,400 67,200 216,600 90,000 81,000 91,200 262,200 75,600 90,000 108,000 273,600 126,000 171,000 202,500 225,000 189,000 198,000 144,000 126,000 171,000 202,500 225,000 189,000 198,000 202,700 190,800 165,600 195,600 216,600 262,200 273,600 144,000 12,000 20,000 126,000 12,000 20,000 171,000 12,000 20,000 26,500 202,500 12,000 20,000 14 $176,000 $158,000 225,000 12,000 20,000 403 189,000 12,000 20,000 26,500 811 198,000 12,000 20,000 672 $229,500 $234,514 $257,403 $248,311 $230,672 -$38,914 -$40,803 Net Monthly Change $26,700 $32,800 -$63,900 Analysis of Borrowing Needs Beginning Cash Balance Ending Cash (No Borrow) Needed (Borrowing) Loan Repayment Ending Cash Balance Cumulative Borrowing 28,000 54,700 0 $54,700 54,700 87,500 0 $87,500 87,500 23,600 1,400 $25,000 1,400 25,000 -13,914 38,914 $25,000 $40,314 $13,889 $42,928 25,000 25,000 -15,803 38,889 40,803 (13,889) $25,000 $ 25,000 $81,117 $67,228 25,000 67,928 (42,928) $25,000 24,300 August 264,000 Cash Budget for January thru July based on a 20% decrease in sales Nov Dec Jan Feb Mar Apr Sales 230,000 225,000 96,000 128,000 112,000 152,000 Collections: Month of sales 28,800 38,400 33,600 45,600 First month 67,500 28,800 38,400 33,600 Second month 92,000 90,000 38,400 51,200 Total Collections 188,300 157,200 110,400 130,400 Purchases 72,000 Payments Cash Receipts (collections) 96,000 72,000 89 Cash Disbursements Payments for Purchases Rent Other Expenditures Tax Deposits Interest on Short-Term Borrowing Total Disbursements May 180,000 June 200,000 July 168,000 54,000 45,600 44,800 144,400 60,000 54,000 60,800 174,800 50,400 60,000 72,000 182,400 84,000 114,000 135,000 150,000 126,000 132,000 96,000 84,000 114,000 135,000 150,000 126,000 1320,000 188,300 157,200 110,400 130,400 144,400 174,800 182,400 96,000 12,000 20,000 84,000 12,000 20,000 $128,000 $116,000 114,000 12,000 20,000 26,500 135,000 12,000 20,000 150,000 12,000 20,000 126,000 12,000 20,000 26,500 318 132,000 12,000 20,000 418 $172,500 $167,000 $182,000 $184,818 $164,418 -$36,600 -$37,600 -$10,018 Net Monthly Change $60,300 $41,200 -$62,100 Analysis of Borrowing Needs Beginning Cash Balance Ending Cash (No Borrow) Needed (Borrowing) Loan Repayment Ending Cash Balance Cumulative Borrowing 28,000 88,300 88,300 129,500 0 0 $88,300 $129,500 0 129,500 67,400 0 $67,400 67,400 30,800 0 $30,800 30,800 25,000 -6,800 14,982 31,800 10,018 0 $25,000 $ 25,000 $31,800 $41,818 $17,982 25,000 42,982 (17,982) $25,000 23,836 August 176,000 b Halsey will not be able to retire the $200,000 note at the end of July July Ending Cash Balance $25,000 25,000 25,000 Sales Levels Expected +20% -20% 90 ... 72,000 80,000 66,000 200,000 214,000 178,000 104, 000 93,600 104, 000 104, 000 93,600 200,000 214,000 178,000 62,400 78,000 156,000 143,000 104, 000 104, 000 93,600 10,000 20,000 10,000 20,000 10,000... be invested SOLUTIONS TO END-OF -CHAPTER PROBLEMS Solutions to Problem Set A 4-1A Sales Net Income Current Assets Net fixed assets Total Assets 2003 12,000,000 1,200,000 % of Sales 2 004 15,000,000... variable) cash budget gives the firm's management more information regarding the range of possible financing needs of the firm, and secondly, it provides management with a standard against which