Chap 4 Solutions

Chapter 04: Financial Forecasting

Chapter 4Financial Forecasting

Discussion Questions

4-1. What are the basic benefits and purposes of developing pro forma statements and a cash budget?

The pro-forma financial statements and cash budget enable the firm to determine its future level of asset needs and the associated financing that will be required. Furthermore, one can track actual events against the projections. Bankers and other lenders also use these financial statements as a guide in credit decisions.

4-2. Explain how the collections and purchases schedules are related to the borrowing needs of the corporation.

The collections and purchase schedules measure the speed at which receivables are collected and purchases are paid. To the extent collections do not cover purchasing costs and other financial requirements, the firm must look to borrowing to cover the deficit.

4-3. With inflation, what are the implications of using LIFO and FIFO inventory methods? How do they affect the cost of goods sold?

LIFO inventory valuation assumes the latest purchased inventory becomes part of the cost of goods sold, while the FIFO method assigns inventory items that were purchased first to the cost of goods sold. In an inflationary environment, the LIFO method will result in a higher cost of goods sold figure and one that more accurately matches the sales dollars recorded at current dollars.

4-4. Explain the relationship between inventory turnover and purchasing needs.

The more rapid the turnover of inventory, the greater the need for purchase and replacement. Rapidly turning inventory makes for somewhat greater ease in foreseeing future requirements and reduces the cost of carrying inventory.

4-5. Rapid corporate growth in sales and profits can cause financing problems. Elaborate on this statement.

Rapid growth in sales and profits is often associated with rapid growth in asset commitment. A $100,000 increase in sales may cause a $50,000 increase in assets, with perhaps only $10,000 of the new financing coming from profits. It is very seldom that incremental profits from sales expansion can meet new financing needs.

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4-6. Discuss the advantage and disadvantage of level production schedules in firms with cyclical sales.

Level production in a cyclical industry has the advantage of allowing for the maintenance of a stable work force and reducing inefficiencies caused by shutting down production during slow periods and accelerating work during crash production periods. A major drawback is that a large stock of inventory may be accumulated during the slow sales period. This inventory may be expensive to finance, with an associated danger of obsolescence.

4-7. What conditions would help make a percent-of-sales forecast almost as accurate as pro forma financial statements and cash budgets?

The percent-of-sales forecast is only as good as the functional relationship of assets and liabilities to sales. To the extent that past relationships accurately depict the future, the percent-of-sales method will give values that reasonably represent the values derived through the pro-forma statements and the cash budget.

Chapter 4

Problems

1. Growth and financing (LO4) Philip Morris is excited because sales for his clothing company are expected to double from $500,000 to $1,000,000 next year. Philip notes that net assets (Assets Liabilities) will remain at 50 percent of Sales. His clothing firm will enjoy a 9 percent return on total sales. He will start the year with $100,000 in the bank and is already bragging about the two Mercedes he will buy and the European vacation he will take. Does his optimistic outlook for his cash position appear to be correct?

Compute his likely cash balance or deficit for the end of the year. Start with beginning cash and subtract the asset buildup (equal to 50 percent of the sales increase) and add in profit.

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4-1. Solution:

Philip Morris

Beginning cash $100,000– Asset buildup (250,000) (1/2 × $500,000)Profit 90,000 (9% × $1,000,000)Ending cash ($60,000) Deficit

2. Growth and financing (LO4) In Problem 1 if there had been no increase in sales and all other facts were the same, what would Philip’s ending cash balance be? What lesson do the examples in Problems 1 and 2 illustrate?

4-2. Solution:

Philip Morris (continued)

Beginning cash $100,000No asset buildup -----Profit 45,000 (9% × $500,000)Ending cash $145,000

The lesson to be learned is that increased sales can increase the financing requirements and reduce cash even for a profitable firm.

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3. Growth and financing (LO4) Galehouse Gas Stations Inc., expects sales to increase from $1,500,000 to $1,700,000 next year. Mr. Galehouse believes that net assets (Assets Liabilities) will represent 70% of sales. His firm has a 10 percent return on sales and pays 40% of profits out as dividends.

a. What effect will this growth have on funds?

b. If the dividend payout is only 15%, what effect will this growth have on funds?

4-3. Solution:

Galehouse Gas Stations, Inc.

a. Asset buildup ($140,000) (70% × $200,000)Profit 170,000 (10% × $1,700,000)Dividends (68,000) (40% × $170,000)Change in cash (38,000)

The cash balance will be reduced by $38,000.

b. Dividends would only be $25,500 (15% × $170,000).

The change in cash would be a positive $4,500.

Asset buildup ($140,000)Profit 170,000Dividends (25,500)Change in cash $4,500

The cash balance will increase by $4,500.

4. Sales projections (LO2) The Alliance Corp. expects to sell the following number of units of copper cables at the prices indicated, under three different scenarios in the economy. The probability of each outcome is indicated. What is the expected value of the total sales projection?

Outcome Probability Units PriceA 0.30 200 $15B 0.50 320 30C 0.20 410 40

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4-4. Solution:

Alliance Corporation

(1) (2) (3) (4) (5) (6)

Outcome Probability Units PriceTotal Value

Expected Value (2 × 5)

A .30 200 $15 $3,000 $ 900B .50 320 $30 9,600 4,800C .20 410 $40 16,400 3,280

Total expected value $8,980

5. Sales projections (LO2) Bronco Truck Parts expects to sell the following number of units at the prices indicated under three different scenarios in the economy. The probability of each outcome is indicated. What is the expected value of the total sales projection?

Outcome Probability Units PriceA 0.20 300 $16B 0.50 500 $25C 0.30 1,000 $30

4-5. Solution:

Bronco Truck Parts

(1) (2) (3) (4) (5) (6)

Outcome Probability Units PriceTotal Value

Expected Value (2 × 5)

A .20 300 $16 $4,800 $ 960B .50 500 25 12,500 6,250C .30 1,000 30 30,000 9,000

Total expected value $16,210

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6. Sales projections (LO2) Cyber Security Systems had sales of 3,000 units at $50 per unit last year. The marketing manager projects a 20 percent increase in unit volume sales this year with a 10 percent price increase. Returned merchandise will represent 6 percent of total sales. What is your net dollar sales projection for this year?

4-6. Solution:

Cyber Security Systems

Unit volume 3,000 × 1.20......................... 3,600Price $50 × 1.10………………… × $55 Total Sales…………………………........... $198,000Returns (6%)………………………........... 11,880Net Sales…………………………….......... $186,120

7. Sales projections (LO2) Dodge Ball Bearings had sales of 10,000 units at $20 per unit last year. The marketing manager projects a 30 percent increase in unit volume sales this year with a 5 percent price decrease (due to a price reduction by a competitor). Returned merchandise will represent 3 percent of total sales. What is your net dollar sales projection for this year?

4-7. Solution:

Dodge Ball Bearings

Unit volume 10,000 × 1.30....................... 13,000Price $20 × .95.............................. × $19Total Sales................................................... $247,000Returns (3%)............................................... 7,410Net Sales...................................................... $239,590

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8. Production requirements (LO2) Sales for Western Boot Stores are expected to be 40,000 units for October. The company likes to maintain 15 percent of unit sales for each month in ending inventory (i.e., the end of October). Beginning inventory for October is 8,500 units. How many units should Western Boot produce for the coming month?

4-8. Solution:

Western Boot Stores

+ Projected sales.................................... 40,000 units+ Desired ending inventory................... 6,000 (15% × 40,000)– Beginning inventory........................... 8,500Units to be produced............................. 37,500

9. Production requirements (LO2) Vitale Hair Spray had sales of 8,000 units in March. A 50 percent increase is expected in April. The company will maintain 5 percent of expected unit sales for April in ending inventory. Beginning inventory for April was 400 units. How many units should the company produce in April?

4-9. Solution:

Vitale Hair Spray

+ Projected sales............................. 12,000 units (8,000 × 1.50)+ Desired ending inventory............. 600 (5% × 12,000)– Beginning inventory..................... 400Units to be produced....................... 12,200

10. Production requirements (LO2) Delsing Plumbing Company has beginning inventory of 14,000 units, will sell 50,000 units for the month, and desires to reduce ending inventory to 40 percent of beginning inventory. How many units should Delsing produce?

4-10. Solution:

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Delsing Plumbing Company

+ Projected sales............................. 50,000 units+ Desired ending inventory............. 5,600 (40% × 14,000)– Beginning inventory..................... 14,000Units to be produced....................... 41,600

11. Cost of goods sold—FIFO (LO2) On December 31 of last year, Wolfson Corporation had in inventory 400 units of its product, which cost $21 per unit to produce. During January, the company produced 800 units at a cost of $24 per unit. Assuming that Wolfson Corporation sold 700 units in January, what was the cost of goods sold (assume FIFO inventory accounting)?

4-11. Solution:

Wolfson Corporation

Cost of goods sold on 700 units

Old inventory: Quantity (Units).................. 400 Cost per unit........................ $ 21 Total.................................... $ 8,400

New inventory: Quantity (Units).................. 300 Cost per unit........................ $ 24 Total $ 7,200Total Cost of Goods Sold...... $15,600

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12. Cost of goods sold—FIFO (LO2) At the end of January, Higgins Data Systems had an inventory of 600 units, which cost $16 per unit to produce. During February the company produced 850 units at a cost of $19 per unit. If the firm sold 1,100 units in February, what was its cost of goods sold (assume LIFO inventory accounting)?

4-12. Solution:

Higgins Data System

Cost of goods sold on 1,100 units

New inventory: Quantity (Units)............... 850 Cost per unit..................... $ 19 Total................................. $16,150

Old inventory: Quantity (Units)............... 250 Cost per unit..................... $ 16 Total................................. $ 4,000Total Cost of Goods Sold... $20,150

13. Cost of goods sold—LIFO and FIFO (LO2) At the end of January, Mineral Labs had an inventory of 725 units, which cost $10 per unit to produce. During February the company produced 650 units at a cost of $14 per unit. If the firm sold 1,000 units in February, what was the cost of goods sold?

a. Assume LIFO inventory accounting.b. Assume FIFO inventory accounting.

4-13. Solution:

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Mineral Labs

a. LIFO Accounting

Cost of goods sold on 1,000 unitsNew inventory:

Quantity (Units)..................................... 650Cost per unit........................................... $ 14Total....................................................... $ 9,100

Old inventory:Quantity (Units)..................................... 350Cost per unit........................................... $ 10Total....................................................... $ 3,500

Total Cost of Goods Sold........................... $12,600

b. FIFO Accounting

Cost of goods sold on 1,000 unitsOld inventory:

Quantity (Units)..................................... 725Cost per unit........................................... $ 10Total....................................................... $ 7,250

New inventory:Quantity (Units)..................................... 275Cost per unit........................................... $ 14Total....................................................... $ 3,850

Total Cost of Goods Sold........................... $11,100

14. Gross profit and ending inventory (LO2) The Bradley Corporation produces a product with the following costs as of July 1, 2011:

Material................. $ 2 per unit

Labor..................... 4 per unit

Overhead............... 2 per unit

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Beginning inventory at these costs on July 1 was 3,000 units. From July 1 to December 1, 2011, Bradley produced 12,000 units. These units had a material cost of $3, labor of $5, and overhead of $3 per unit. Bradley uses FIFO inventory accounting.

Assuming that Bradley sold 13,000 units during the last six months of the year at $16 each, what is its gross profit? What is the value of ending inventory?

4-14. Solution:

Bradley Corporation

Sales (13,000 @ $16) $208,000Cost of goods sold:Old inventory: Quantity (units)............ 3,000 Cost per unit................. $ 8Total............................... $ 24,000New inventory: Quantity (units)............ 10,000 Cost per unit................. $ 11Total............................... $ 110,000Total cost of goods

sold.............................. $134,000Gross profit.................... $ 74,000

Value of ending inventory:Beginning inventory (3,000 $8).................

$ 24,000

+ Total production (12,000 $11)............. $132,000Total inventory available for sale.......... $156,000

– Cost of good sold....... $134,000Ending inventory............ $ 22,000

Or2,000 units $11 = $22,000

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15. Gross profit and ending inventory (LO2) Assume in Problem 14 that the Bradley Corporation used LIFO accounting instead of FIFO; what would its gross profit be? What would be the value of ending inventory?

4-15. Solution:

Bradley Corporation(Continued)

Sales (13,000 @ $16) $208,000Cost of goods sold:New inventory: Quantity (units)............ 12,000 Cost per unit................. $ 11Total............................... $132,000Old inventory: Quantity (units)............ 1,000 Cost per unit................. $ 8Total............................... $ 8,000Total cost of goods

sold.............................. $140,000Gross profit.................... $ 68,000

Value of ending inventory:Beginning inventory (3,000 $8).................

$ 24,000

+ Total production (12,000 $11)............. $132,000Total inventory available for sale.......... $156,000

– Cost of good sold....... $140,000Ending inventory............ $ 16,000

Or2,000 units $8 = $16,000

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16. Gross profit and ending inventory (LO2) Sprint Shoes, Inc., had a beginning inventory of 9,000 units on January 1, 2010. The costs associated with the inventory were:

Material................. $13.00 per unit

Labor..................... 8.00 per unit

Overhead............... 6.10 per unit

During 2010, the firm produced 42,500 units with the following costs:

Material................. $15.50 per unit

Labor..................... 7.80 per unit

Overhead............... 8.30 per unit

Sales for the year were 47,250 units at $39.60 each. Sprint Shoes uses LIFO accounting. What was the gross profit? What was the value of ending inventory?

4-16. Solution:

Sprint Shoes, Inc.

Sales (47,250 @ $39.60) $1,871,100Cost of goods sold:New inventory: Quantity (units)............ 42,500 Cost per unit................. $ 31.60Total............................... $1,343,000Old inventory: Quantity (units)............ 4,750 Cost per unit................. $ 27.10Total............................... $ 128,725Total cost of goods

sold.............................. $1,471,725Gross profit.................... $ 399,375

Value of ending inventory:Beginning inventory (9,000 $27.10).......... $ 243,900

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+ Total production (42,500 $31.60)........ $1,343,000Total inventory available for sale.......... $1,586,900

– Cost of good sold....... $1,471,725Ending inventory............ $ 115,175

Or42,500 units $27.10 = $115,175

17. Schedule of cash receipts (LO2) Victoria’s Apparel has forecast credit sales for the fourth quarter of the year as:

September (actual).......... $50,000

Fourth QuarterOctober............................ $40,000

November........................ 35,000

December........................ 60,000

Experience has shown that 20 percent of sales receipts are collected in the month of sale, 70 percent in the following month, and 10 percent are never collected.

Prepare a schedule of cash receipts for Victoria's Apparel covering the fourth quarter (October through December).

4-17. Solution:

Victoria’s Apparel

September October November DecemberCredit sales $50,000 $40,000 $35,000 $60,00020% Collected in month of sales

8,000 7,000 12,000

70% Collected in month after sales

35,000 28,000 24,500

Total cash receipts

$43,000 $35,000 $36,500

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18. Schedule of cash receipts (LO2) Simpson Glove Company has made the following sales projections for the next six months. All sales are credit sales.

March.............................. $36,000

April................................ 45,000

May................................. 27,000

June................................. 42,000

July.................................. 53,000

August............................. 57,000

Sales in January and February were $41,000 and $39,000 respectively. Experience has shown that of total sales receipts 10 percent are uncollectible, 40 percent are collected in the month of sale, 30 percent are collected in the following month, and 20 percent are collected two months after sale.

Prepare a monthly cash receipts schedule for the firm for March through August.

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4-18. Solution:

Simpson Glove CompanyCash Receipts Schedule

January February March April May June July AugustSales $41,000 $39,000 $36,000 $45,000 $27,000 $42,000 $53,000 $57,000Collections (40% of current sales)

14,400 18,000 10,800 16,800 21,200 22,800

Collections (30% of prior month’s sales)

11,700 10,800 13,500 8,100 12,600 15,900

Collections (20% of sales 2 months earlier)

8,200 7,800 7,200 9,000 5,400 8,400

Total cash receipts

$34,300 $36,600 $31,500 $33,900 $39,200 $47,100

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19. Schedule of cash receipts (LO2) Watt's Lighting Stores made the following sales projection for the next six months. All sales are credit sales.

March.............................. $30,000

April................................ 36,000

May................................. 25,000

June................................. 34,000

July.................................. 42,000

August............................. 44,000

Sales in January and February were $33,000 and $32,000, respectively.

Experience has shown that of total sales, 10 percent are uncollectible, 30 percent are collected in the month of sale, 40 percent are collected in the following month, and 20 percent are collected two months after sale.

Prepare a monthly cash receipts schedule for the firm for March through August.

Of the sales expected to be made during the six months from March through August, how much will still be uncollected at the end of August? How much of this is expected to be collected later?

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4-19. Solution:Watt’s Lighting StoresCash Receipts Schedule

January February March April May June July AugustSales $33,000 $32,000 $30,000 $36,000 $25,000 $34,000 $42,000 $44,000Collections (30% of current sales)

9,000 10,800 7,500 10,200 12,600 13,200

Collections (40% of prior month’s sales)

12,800 12,000 14,400 10,000 13,600 16,800

Collections (20% of sales 2 months earlier)

6,600 6,400 6,000 7,200 5,000 6,800

Total cash receipts

$28,400 $29,200 $27,900 $27,400 $31,200 $36,800

Still due (uncollected) in August:Bad debts: ($30,000 + 36,000 + 25,000 + 34,000 + 42,000 + 44,000) × .1 = (211,000) × .1 = $21,100To be collected from July sales: ($42,000 × .20) = $8,400To be collected from August sales: ($44,000 × .60) = $26,400$21,100 + $8,400 + $26,400 = $55,900 dueExpected to be collected:$55,900 due – $21,100 bad debts = $34,800

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20. Schedule of cash payments (LO2) Ultravision, Inc., anticipates sales of $240,000 from January through April. Materials will represent 50 percent of sales and because of level production, material purchases will be equal for each month during the four months of January, February, March, and April.

Materials are paid for one month after the month purchased. Materials purchased in December of last year were $20,000 (half of $40,000 in sales). Labor costs for each of the four months are slightly different due to a provision in the labor contract in which bonuses are paid in February and April. The labor figures are:

January............................ $10,000

February.......................... 13,000

March.............................. 10,000

April................................ 15,000

Fixed overhead is $6,000 per month. Prepare a schedule of cash payments for January through April.

4-19


4-20. Solution:

Ultravision, Inc.Cash Payment Schedule

Dec. Jan. Feb. March April* Purchases $20,000 $30,000 $30,000 $30,000 $30,000** Payment to material purchases 20,000 30,000 30,000 30,000

Labor 10,000 13,000 10,000 15,000Fixed overhead 6,000 6,000 6,000 6,000Total Cash Payments $36,000 $49,000 $46,000 $51,000

For January through April

* Monthly purchases equal ($240,000 50%)/4 or $120,000/4 $30,000

** Payment is equal to prior month’s purchases.

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21. Schedule of cash payments (LO2) The Denver Corporation has forecast the following sales for the first seven months of the year:

January………........ $10,000 May……… $10,000

February………...... 12,000 June……… 16,000

March……….......... 14,000 July…….. 18,000

April………............ 20,000

Monthly material purchases are set equal to 30 percent of forecasted sales for the next month. Of the total material costs, 40 percent are paid in the month of purchase and 60 percent in the following month. Labor costs will run $4,000 per month, and fixed overhead is $2,000 per month. Interest payments on the debt will be $3,000 for both March and June. Finally, the Denever salesforce will receive a 1.5 percent commission on total sales for the first six months of the year, to be paid on June 30.

Prepare a monthly summary of cash payments for the six-month period from January through June. (Note: Compute prior December purchases to help get total material payments for January.)

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4-21. Solution:

Denver CorporationCash Payments Schedule

Dec. Jan. Feb. March April May June JulySales $10,000 $12,000 $14,000 $20,000 $10,00

0$16,000 $18,000

Purchases (30% of next month’s sales)

3,000 3,600 4,200 6,000 3,000 4,800 5,400

Payment (40% of current purchases)

1,440 1,680 2,400 1,200 1,920 2,160

Material payment (60% of previous month’s purchases)

1,800 2,160 2,520 3,600 1,800 2,880

Total payment for materials

3,240 3,840 4,920 4,800 3,720 5,040

Labor costs 4,000 4,000 4000 4,000 4,000 4,000Fixed overhead 2,000 2,000 2,000 2,000 2,000 2,000Interest payments 3,000 3,000Sales commission (1.5% of $82,000)

1,230

Total payments $ 9,240 $ 9,840 $13,920 $10,800 $ 9,720

$15,270

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22. Schedule of cash payments (LO2) The Boswell Corporation forecasts its sales in units for the next four months as follows:

March……….......... 6,000

April…………........ 8,000

May…………......... 5,500

June…………......... 4,000

Boswell maintains an ending inventory for each month in the amount of one and one-half times the expected sales in the following month. The ending inventory for February (March's beginning inventory) reflects this policy. Materials cost $5 per unit and are paid for in the month after production. Labor cost is $10 per unit and is paid for in the month incurred. Fixed overhead is $12,000 per month. Dividends of $20,000 are to be paid in May. Five thousand units were produced in February.

Complete a production schedule and a summary of cash payments for March, April, and May. Remember that production in any one month is equal to sales plus desired ending inventory minus beginning inventory.

4-22. Solution:

Boswell CorporationProduction Schedule

March April May JuneForecasted unit sales 6,000 8,000 5,500 4,000+Desired ending inventory

12,000 8,250 6,000

–Beginning inventory 9,000 12,000 8,250Units to be produced 9,000 4,250 3,250

Cash PaymentsFeb March April May

Units produced 5,000 9,000 4,250 3,250Materials ($5/unit) month after production

$25,000 $45,000 $21,250

Labor ($10/unit) month of production

90,000 42,500 32,500

Fixed overhead 12,000 12,000 12,000Dividends 20,000Total Cash Payments $127,000 $99,500 $85,750

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23. Schedule of cash payments (LO2) The Volt Battery Company has forecast its sales in units as follows:

January………........ 800 May……… 1,350

February………...... 650 June……… 1,500

March……….......... 600 July……… 1,200

April………............ 1,100

Volt Battery always keeps an ending inventory equal to 120 percent of the next month's expected sales. The ending inventory for December (January's beginning inventory) is 960 units, which is consistent with this policy.

Materials cost $12 per unit and are paid for in the month after purchase. Labor cost is $5 per unit and is paid in the month the cost is incurred. Overhead costs are $6,000 per month. Interest of $8,000 is scheduled to be paid in March, and employee bonuses of $13,200 will be paid in June.

Prepare a monthly production schedule and a monthly summary of cash payments for January through June. Volt produced 600 units in December.

4-24


4-23. Solution:

Volt Battery CompanyProduction Schedule

Jan. Feb. March April May June JulyForecasted unit sales 800 650 600 1,100 1,350 1,500 1,200+ Desired ending inventory 780 720 1,320 1,620 1,800 1,440– Beginning inventory 960 780 720 1,320 1,620 1,800= Units to be produced 620 590 1,200 1,400 1,530 1,140

Summary of Cash PaymentsDec. Jan. Feb. March April May June

Units produced 600 620 590 1,200 1,400 1,530 1,140Material cost ($12/unit) month after purchase

$ 7,200 $ 7,440 $ 7,080 $14,400 $16,800 $18,360

Labor cost ($5/unit) month incurred

3,100 2,950 6,000 7,000 7,650 $ 5,700

Overhead cost 6,000 6,000 6,000 6,000 6,000 6,000Interest 8,000Employee bonuses 13,200Total Cash Payments $16,300 $16,390 $27,080 $27,400 $30,450 $43,260

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24. Cash Budget (LO2) Lansing Auto Parts, Inc., has projected sales of $25,000 in October, $35,000 in November, and $30,000 in December. Of the company's sales, 20 percent are paid for by cash and 80 percent are sold on credit. The credit sales are collected one month after sale. Determine collections for November and December.

Also assume that the company's cash payments for November and December are $30,400 and $29,800, respectively. The beginning cash balance in November is $6,000, which is the desired minimum balance.

Prepare a cash budget with borrowing needed or repayments for November and December. (You will need to prepare a cash receipts schedule first.)

4-24. Solution:

Lansing Auto Parts, Inc.Cash Receipts Schedule

October November DecemberSales $25,000 $35,000 $30,000Cash sales (20%) 7,000 6,000Collections (80% of previous month’s sales) 20,000 28,000Total cash receipts $27,000 $34,000

Lansing Auto Parts, Inc.Cash Budget

November JulyCash Receipts $27,000 $34,000Cash Payments 30,400 29,800Net Cash Flow (3,400) 4,200Beginning Cash Balance 6,000 6,000Cumulative Cash Balance 2,600 10,200Monthly Loan or (Repayment) 3,400 (3,400)Cumulative Loan Balance 3,400 -0-Ending Cash Balance $ 6,000 $ 6,800

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25. Complete cash budget (LO2) Harry's Carryout Stores has eight locations. The firm wishes to expand by two more stores and needs a bank loan to do this. Mr. Wilson, the banker, will finance construction if the firm can present an acceptable three-month financial plan for January through March. The following are actual and forecasted sales figures:

Actual Forecast Additional Information

November........... $200,000 January............ $280,000 April forecast...... $330,000

December............ 220,000 February.......... 320,000

March……….. 340,000

Of the firm's sales, 40 percent are for cash and the remaining 60 percent are on credit. Of credit sales, 30 percent are paid in the month after sale and 70 percent are paid in the second month after the sale. Materials cost 30 percent of sales and are purchased and received each month in an amount sufficient to cover the following month's expected sales. Materials are paid for in the month after they are received. Labor expense is 40 percent of sales and is paid for in the month of sales. Selling and administrative expense is 5 percent of sales and is also paid in the month of sales. Overhead expense is $28,000 in cash per month.

Depreciation expense is $10,000 per month. Taxes of $8,000 will be paid in January, and dividends of $2,000 will be paid in March. Cash at the beginning of January is $80,000, and the minimum desired cash balance is $75,000.

For January, February, and March, prepare a schedule of monthly cash receipts, monthly cash payments, and a complete monthly cash budget with borrowings and repayments.

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4-25. Solution:

Harry’s Carry-Out StoresCash Receipts Schedule

November December January February March AprilSales $200,000 $220,000 $ 280,000 $320,000 $340,000 $330,000Cash sales (40%) 80,000 88,000 112,000 128,000 136,000 132,000Credit sales (60%) 120,000 132,000 168,000 192,000 204,000 198,000Collections (month after credit sales) 30%

36,000 39,600 50,400 57,600 61,200

Collections (two months after credit sales) 70%

84,000 92,400 117,600 134,400

Total Cash Receipts

$235,600 $270,800 $311,200

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4-25. (Continued)Harry’s Carry-Out StoresCash Payments Schedule

January February MarchPayments for Purchases (30% of next month’s sales paid in month after purchases—equivalent to 30% of current sales)........................................

$ 84,000 $ 96,000 $102,000

Labor Expense (40% of sales).............................. 112,000 128,000 136,000Selling and Admin. Exp. (5% of sales)................ 14,000 16,000 17,000Overhead.............................................................. 28,000 28,000 28,000Taxes.................................................................... 8,000Dividends............................................................. 2,000Total Cash Payments*.......................................... $246,600 $268,000 $285,000

*The $10,000 of depreciation is excluded because it is not a cash expense.

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4-25. (Continued)

Harry’s Carry-Out StoresCash Budget

January February MarchTotal Cash Receipts............................. $235,600 $270,800 $311,200Total Cash Payments........................... 246,000 268,000 285,000Net Cash Flow..................................... (10,400) 2,800 26,200Beginning Cash Balance...................... 80,000 75,000 75,000Cumulative Cash Balance.................... 69,600 77,800 101,200Monthly Loan or (repayment)............. 5,400 (2,800) (2,600)Cumulative Loan Balance................... 5,400 2,600 -0-Ending Cash Balance........................... $ 75,000 $ 75,000 $ 98,600

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26. Complete cash budget (LO2) Archer Electronics Company's actual sales and purchases for April and May are shown here along with forecasted sales and purchases for June through September.

Sales Purchases

April (actual).................................... $320,000 $130,000May (actual)...................................... 300,000 120,000June (forecast)................................... 275,000 120,000July (forecast)................................... 275,000 180,000August (forecast).............................. 290,000 200,000September (forecast)......................... 330,000 170,000

The company makes 10 percent of its sales for cash and 90 percent on credit. Of the credit sales, 20 percent are collected in the month after the sale and 80 percent are collected two months later. Archer pays for 40 percent of its purchases in the month after purchase and 60 percent two months after.

Labor expense equals 10 percent of the current month's sales. Overhead expense equals $12,000 per month. Interest payments of $30,000 are due in June and September. A cash dividend of $50,000 is scheduled to be paid in June. Tax payments of $25,000 are due in June and September. There is a scheduled capital outlay of $300,000 in September.

Archer Electronics's ending cash balance in May is $20,000. The minimum desired cash balance is $10,000. Prepare a schedule of monthly cash receipts, monthly cash payments, and a complete monthly cash budget with borrowing and repayments for June through September. The maximum desired cash balance is $50,000. Excess cash (above $50,000) is used to buy marketable securities. Marketable securities are sold before borrowing funds in case of a cash shortfall (less than $10,000).

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4-26. Solution:

Archer ElectronicsCash Receipts Schedule

April May June July Aug. Sept.Sales $320,000 $300,000 $ 275,000 $275,000 $290,000 $330,000

Cash Sales (10%) 32,000 30,000 27,500 27,500 29,000 33,000Credit Sales (90%) 288,000 270,000 247,500 247,500 261,000 297,000

Collections (month after sale) 20%

57,600 54,000 49,500 49,500 52,200

Collections (second month after sale) 80%

230,400 216,000 198,000 198,000

Total Cash Receipts

$311,900 $293,000 $276,500 $283,200

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4-26. (Continued)Archer Electronics

Cash Payments Schedule

April May June July Aug. Sept.Purchases $130,000 $120,000 $120,000 $180,000 $200,000 $170,000Payments (month after purchase—40%)

52,000 48,000 48,000 72,000 80,000

Payments (second month after purchase—60%)

78,000 72,000 72,000 108,000

Labor Expense (10% of sales)

27,500 27,500 29,000 33,000

Overhead 12,000 12,000 12,000 12,000Interest Payments 30,000 30,000Cash Dividend 50,000Taxes 25,000 25,000Capital Outlay 300,000Total Cash Payments $270,500 $159,500 $185,000 $588,000

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4-26. (Continued)

Archer ElectronicsCash Budget

June July August SeptemberCash Receipts.......................................... $311,900 $293,000 $276,500 $283,200Cash Payments......................................... 270,500 159,500 185,000 588,000Net Cash Flow......................................... 41,400 133,500 91,500 (304,800)Beginning Cash Balance.......................... 20,000 50,000 50,000 50,000Cumulative Cash Balance........................ 61,400 183,500 141,500 (254,800)Monthly Borrowing or (Repayment) ...... -- -- -- *28,400Cumulative Loan Balance....................... -- -- -- 28,400Marketable Securities Purchased............. 11,400 133,500 91,500 --

(Sold) -- -- (236,400)Cumulative Marketable Securities........... 11,400 144,900 236,400 --Ending Cash Balance............................... 50,000 50,000 50,000 10,000

*Cumulative Marketable Sec. (Aug) $236,400Cumulative Cash Balance (Sept) –254,800Required (ending) Cash Balance –10,000Monthly Borrowing –$28,400

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27. Percent-of-sales method (LO3) Owen's Electronics has 9 operating plants in seven southwestern states. Sales for last year were $100 million, and the balance sheet at year-end is similar in percentage of sales to that of previous years (and this will continue in the future). All assets (including fixed assets) and current liabilities will vary directly with sales. The firm is working at full capacity.

Balance Sheet (in $ millions)

Assets Liabilities and Stockholders' Equity

Cash............................................ $ 2 Accounts payable....................... $15

Accounts receivable................... 20 Accrued wages........................... 2

Inventory.................................... 23 Accrued taxes............................. 8

Current assets........................... $45 Current liabilities...................... $25

Fixed assets................................. 40 Notes payable............................. 10

Common stock............................ 15

Retained earnings....................... 35

Total assets................................. $85Total liabilities and stockholders' equity.................. $85

Owen's has an after tax profit margin of 7 percent and a dividend payout ratio of 40 percent.

If sales grow by 10 percent next year, determine how many dollars of new funds are needed to finance the growth.

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4-27. Solution:

Owen’s Electronics

At Full Capacity

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28. Percent-of-sales method (LO3) The Manning Company has financial statements as shown below, which are representative of the company's historical average.

The firm is expecting a 20 percent increase in sales next year, and management is concerned about the company's need for external funds. The increase in sales is expected to be carried out without any expansion of fixed assets, but rather through more efficient asset utilization in the existing store. Among liabilities, only current liabilities vary directly with sales.

Using the percent-of-sales method, determine whether the company has external financing needs, or a surplus of funds. (Hint: A profit margin and payout ratio must be found from the income statement.)

Income StatementSales............................................................. $200,000Expenses....................................................... 158,000 Earnings before interest and taxes................ $ 42,000Interest.......................................................... 7,000 Earnings before taxes................................... $ 35,000Taxes............................................................ 15,000 Earnings after taxes...................................... $ 20,000Dividends..................................................... $ 6,000

Balance SheetAssets Liabilities and Stockholders' Equity

Cash.............................................. $ 5,000 Accounts payable.......................... $ 25,000Accounts receivable...................... 40,000 Accrued wages.............................. 1,000Inventory....................................... 75,000 Accrued taxes............................... 2,000 Current assets.............................. $120,000 Current liabilities........................ $ 28,000Fixed assets................................... 80,000 Notes payable............................... 7,000

Long-term debt............................. 15,000Common stock.............................. 120,000Retained earnings......................... 30,000

Total assets................................... $200,000Total liabilities and stockholders' equity.................... $200,000

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4-28. Solution:

Manning Company

The firm needs $1,600 in external funds.

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29. Percent-of-sales method (LO3) Conn Man's Shops, Inc., a national clothing chain, had sales of $300 million last year. The business has a steady net profit margin of 8 percent and a dividend payout ratio of 25 percent. The balance sheet for the end of last year is shown below.

Balance SheetEnd of Year

(in $ millions)

Assets Liabilities and Stockholders' Equity

Cash................................................. $ 20 Accounts payable.......................... $ 70

Accounts receivable........................ 25 Accrued expenses......................... 20

Inventory......................................... 75 Other payables.............................. 30

Plant and equipment........................ 120 Common stock.............................. 40

Retained earnings......................... 80

Total assets...................................... $240Total liabilities and Stockholders’ equity.................. $240

The firm's marketing staff has told the president that in coming year there will be a large increase in the demand for overcoats and wool slacks. A sales increase of 15 percent is forecast for the company.

All balance sheet items are expected to maintain the same percent-of-sales relationships as last year, except for common stock and retained earnings. No change is scheduled in the number of common stock shares outstanding, and retained earnings will change as dictated by the profits and dividend policy of the firm. (Remember the net profit margin is 8 percent.)

a. Will external financing be required for the company during the coming year?

b. What would be the need for external financing if the net profit margin went up to 9.5 percent and the dividend payout ratio was increased to 50 percent? Explain.

4-29. Solution:

This included fixed assets as the firm is at full capacity.

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Conn Man’s Shops, Inc.

a.

A negative figure for required new funds indicates that an excess of funds ($2.7 mil.) is available for new investment. No external funds are needed.

b.

The net profit margin increased slightly, from 8% to 9.5%, which decreases the need for external funding. The dividend payout ratio increased tremendously, however, from 25% to 50%, necessitating more external financing. The effect of the

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dividend policy change overpowered the effect of the net profit margin change.

COMPREHENSIVE PROBLEM

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Comprehensive Problem 1.

Mansfield Corporation (external funds requirement) (LO4) Mansfield Corporation had 2010 sales of $100 million. The balance sheet items that vary directly with sales and the profit margin are as follows:

Percent

Cash.................................................................. 5%

Accounts receivable...................................................15Inventory....................................................................20Net fixed assets..........................................................40Accounts payable.......................................................15Accruals.....................................................................10Profit margin after taxes.............................................10%

The dividend payout rate is 50 percent of earnings, and the balance in retained earnings at the end of 2010 was $33 million. Notes payable are currently $7 million. Long-term bonds and common stock are constant at $5 million and $10 million, respectively.

a. How much additional external capital will be required for next year if sales increase 15 percent? (Assume that the company is already operating at full capacity.)

b. What will happen to external fund requirements if Mansfield Corporation reduces the payout ratio, grows at a slower rate, or suffers a decline in its profit margin? Discuss each of these separately.

c. Prepare a pro forma balance sheet for 2011 assuming that any external funds being acquired will be in the form of notes payable. Disregard the information in part b in answering this question (that is, use the original information and part a in constructing your pro forma balance sheet).

CP 4-1. Solution:

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Mansfield Corporation

a.

b. If Mansfield reduces the payout ratio, the company will retain more earnings and need less external funds. A slower growth rate means that less assets will have to be financed and in this case, less external funds would be needed. A declining profit margin will lower retained earnings and force Mansfield Corporation to seek more external funds.

c. Balance Sheet—December 31, 2011(Dollars in Millions)

Cash.............................. $ 5.75 Accounts Payable......... $ 17.25Accounts Receivable.... 17.25 Accruals....................... 11.50Inventory....................... 23.00 Notes Payable.............. 17.501

Net Fixed Assets........... 46.00 Long-Term Bonds........ 5.00Common Stock............ 10.00

_____ Retained Earnings........ 38.75 2 $92.00 $92.00

1 Original notes payable plus required new funds. This is the plug figure.2 2011 retained earnings (end of 2010) + PS2 (1-D)

Comprehensive Problem 2

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Marsh Corporation (financial forecasting with seasonal production) (LO5) The difficult part of solving a problem of this nature is to know what to do with the information contained within a story problem. Therefore, this problem will be easier to complete if you rely on Chapter 4 for the format of all required schedules.

The Marsh Corporation makes standard-size 2-inch fasteners, which it sells for $155 per thousand. Mr. Marsh is the majority owner and manages the inventory and finances of the company. He estimates sales for the following months to be:

January............... $263,500 (1,700,000 fasteners)

February............. $186,000 (1,200,000 fasteners)

March................. $217,000 (1,400,000 fasteners)

April................... $310,000 (2,000,000 fasteners)

May..................... $387,500 (2,500,000 fasteners)

Last year Marsh Corporation's sales were $175,000 in November and $232,500 in December (1,500,000 fasteners).

Mr. Marsh is preparing for a meeting with his banker to arrange the financing for the first quarter. Based on his sales forecast and the following information he has provided, your job as his new financial analyst is to prepare a monthly cash budget, monthly and quarterly pro forma income statements, a pro forma quarterly balance sheet, and all necessary supporting schedules for the first quarter.

Past history shows that Marsh Corporation collects 50 percent of its accounts receivable in the normal 30-day credit period (the month after the sale) and the other 50 percent in 60 days (two months after the sale). It pays for its materials 30 days after receipt. In general, Mr. Marsh likes to keep a two-month supply of inventory in anticipation of sales. Inventory at the beginning of December was 2,600,000 units. (This was not equal to his desired two-month supply.)

The major cost of production is the purchase of raw materials in the form of steel rods, which are cut, threaded, and finished. Last year raw material costs were $52 per 1,000 fasteners, but Mr. Marsh has just been notified that material costs have risen, effective January 1, to $60 per 1,000 fasteners. The Marsh Corporation uses FIFO inventory accounting. Labor costs are relatively constant at $20 per thousand fasteners, since workers are paid on a piecework basis. Overhead is allocated at $10 per thousand units, and selling and administrative expense is 20 percent of sales. Labor expense and overhead are direct cash outflows paid in the month incurred, while interest and taxes are paid quarterly.

The corporation usually maintains a minimum cash balance of $25,000, and it puts its excess cash into marketable securities. The average tax rate is 40 percent, and Mr. Marsh usually pays out 50 percent of net income in dividends to stockholders. Marketable securities are sold before funds are borrowed when a cash shortage is faced. Ignore the interest on any short-term borrowings. Interest on the long-term debt is paid in March, as are taxes and dividends.

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As of year-end, the Marsh Corporation balance sheet was as follows:

MARSH CORPORATIONBalance Sheet

December 31, 201X

AssetsCurrent assets: Cash.............................................................. $ 30,000 Accounts receivable...................................... 320,000 Inventory....................................................... 237,800 Total current assets.................................... $ 587,800Fixed assets: Plant and equipment...................................... 1,000,000 Less: Accumulated depreciation................ 200,000 800,000 Total assets...................................................... $1,387,800

Liabilities and Stockholders' EquityAccounts payable............................................ $ 93,600Notes payable.................................................. 0Long-term debt, 8 percent............................... 400,000Common stock................................................ 504,200Retained earnings............................................ 390,000 Total liabilities and stockholders’ equity........ $1,387,800

CP 4-2. Solution:

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Marsh CorporationForecasting with Seasonal Production

Dec. Jan. Feb. Mar.Projected Unit Sales

1,500,000 1,700,000 1,200,000 1,400,000

+Desired Ending Inventory (2 months supply)

2,900,000 2,600,000 3,400,000 4,500,000

Beginning Inventory

2,600,000 2,900,000 2,600,000 3,400,000

Units to be Produced

1,800,000 1,400,000 2,000,000 2,500,000

CP 4-2. (Continued)

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Monthly Cash Payments

Dec. Jan. Feb. Mar.Units to be produced 1,800,000 1,400,000 2,000,000 2,500,000Materials (from previous month) $ 93,600 $ 84,000 $ 120,000Labor ($20 per thousand units) $ 28,000 $ 40,000 $ 50,000Overhead ($10 per thousand units) $ 14,000 $ 20,000 $ 25,000Selling & adm. expense (20% of sales) $ 52,700 $ 37,200 $ 43,400Interest $ 8,000Taxes (40% tax rate) $64,560*Dividends $48,420*Total Payments $188,300 $181,200 $359,380

*See the pro forma income statement, which follows this material later on, for the development of these values.CP 4-2. (Continued)

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Marsh Corporation Monthly Cash Receipts

Nov. Dec. Jan. Feb. Mar.Sales $175,000 $232,500 $263,500 $186,000 $217,000Collections (50% of Previous month)

87,500 116,250 131,750 93,000

Collections (50% of 2 months earlier)

87,500 116,250 131,750

Total Collections

$203,750 $248,000 $224,750

Monthly Cash Flow

January February MarchCash Receipts $203,750 $248,000 $224,750Cash Payments 188,300 181,200 359,380Net Cash Flow 15,450 66,800 (134,630)

CP 4-2. (Continued)

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Marsh Corporation Cash Budget

January February MarchNet Cash Flow $15,450 $66,800 $(134,630)Beginning Cash Balance 30,000 25,000 25,000Cumulative Cash Balance $45,450 $91,800 ($109,630)Loans and (Repayments) -0- -0- 47,380Cumulative Loans -0- -0- 47,380Marketable Securities 20,450 66,800 (87,250)Cumulative Marketable Securities

20,450 87,250 -0-

Ending Cash Balance $25,000 $25,000 $25,000

Marsh CorporationPro Forma Income Statement

Jan. Feb. Mar. TotalSales $263,500 $186,000 $217,000 $666,500Cost of Goods Sold 139,400 98,400 126,000 363,800Gross Profit 124,100 87,600 91,000 302,700Selling and Admin. Expense

52,700 37,200 43,400 133,300

Interest Expense 2,667 2,667 2,666 8,000Net Profit Before Tax $ 68,733 $ 47,733 $ 44,934 $161,400Taxes 27,493 19,093 17,974 64,560Net Profit After Tax $ 41,240 $ 28,640 $ 26,960 $ 96,840Less: Common Dividends

48,420

Increase in Retained Earnings

$ 48,420

CP 4-2. (Continued)

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Marsh Corporation Cost of Goods Sold

Unit Cost per thousand before January 1st

Unit cost per thousand after January 1st

Material........... $52 $60Labor............... 20 20Overhead.......... 10 10

$82 $90

Ending inventory as of December 31 was 2,900,000; therefore, sales for January and February had a cost of goods sold per thousand units of $82, and March sales reflect the increased cost of $90 per thousand units using FIFO inventory methods.

Pro Forma Balance Sheet (March)

Assets Liabilities & Stockholders' Equity

Current Assets: Current Liabilities:Cash $ 25,000 Accounts Payable $ 150,000Accounts Receivable 310,000 Notes Payable 47,380Inventory 405,000 Long-Term Debt 400,000Plant & Equip: Net Plan

800,000 Stockholders' Equity: Common Stock

504,200

Total Assets $1,540,000

Retained Earnings, Total Liabilities & Stockholders' Equity

438,420

$1,540,000

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CP 4-2. (Continued)

Explanation of Changes in the Balance Sheet:Cash = ending cash balance from cash budget in MarchAccounts receivable =

all of March sales plus 50% of Feb. sales

$217,00093,000

$310,000

Inventory = ending inventory in March of 4,500,000 units at $90 per thousand

Plant and equipment did not change since we did not include depreciation.

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Documents

Chap 4 Solutions