Exam 10: Forecasting Financial Statements

Analysts must develop realistic expectations for the outcomes of future business activities. To develop these expectations, analysts build a set of _____________________________.

When projecting operating expenses it is important to determine the mix of fixed and variable costs, one clue suggesting the presence of fixed costs is

To ensure that the financial statements articulate, it is important that the change in the cash balance on the balance sheet each year agrees with

As a firm progresses through the growth life-cycle stage, what type of flexible account will it be more likely to use to balance the balance sheet?

If a company has very low operating leverage (i.e. a low proportion of fixed costs in the cost structure) and no changes are expected in operations

Sparky's sells auto parts. Provided below is selected financial information from the company's 2012 annual report: Fiscal year end (amounts in thousands of dollass) Net sales \ 125,410 \ 106,380 Cost of GoodsSold -104,090 -89,359 GrossProfit \ 21,320 \ 17,021 Inventory \ 31,353 \ 30,850 - Using Sparky's financial information what is the company's inventory turnover ratio for 2012?

Arco is an integrated manufacturer in capital-intensive industry. Nuwak manufactures more commodity-level products in the same industry at the lower end of the market and uses less capital-intensive processes. The following data describe sales and cost of products sold for both firms for Years 3 and 4. ( \amounts in millious) Year 3 Year 4 Arco Sales \ 4,042 \ 5,217 Cost of ProductsSold 3,887 4,554 Gross Profit \ 155 \ 6 HrossMargin 3.8\% 12.7\% Nuwak Sales \ 6,266 \ 11,377 Cost of ProductsSold 5,997 9,129 GrossProfit \ 269 \ 2,248 GrossMargin 4.3\% 19.8\% Industry analysts anticipate the following annual changes in sales for the next five years: Year +1, 5 percent increase; Year +2, 10 percent increase; Year +3, 20 percent increase; Year +4, 10 percent decrease; Year +5, 20 percent decrease. Required a. The analyst can sometimes estimate the variable cost as a percentage of sales for a particular cost (for example, cost of products sold) by dividing the amount of the change in the cost item between two years by the amount of the change in sales for those two years. The analyst can then multiply the variable-cost percentage times sales to estimate the total variable cost. Subtracting the variable cost from the total cost yields an estimate of the fixed cost for that particular cost item. Follow this procedure to estimate the manufacturing cost structure (variable cost as a percentage of sales, total variable costs, and total fixed costs) for cost of products sold for both Arco and Nuwak in Year 4. b. Discuss the structure of manufacturing cost (that is, fixed versus variable) for each firm in light of the manufacturing process and type of product produced. c. Using the analysts' forecasts of sales changes, compute the projected sales, cost of products sold, gross profit, and gross margin (gross profit as a percentage of sales) of each firm for Year +1 through Year +5. d. Why do the levels and variability of the gross margin percentages differ for these two firms for Year +1 through Year +5?

If a firm competes in a ___________________________________ industry that the analyst expects will operate near capacity for the next few years, then price increases will be more likely.

All of the following are true regarding projected financial statements except:

Simmons Company These data represent a summary of your first-iteration forecast amounts for Year 1. Simmons uses dividends as a flexible financial account. Year + Operating Income \ 58 Interest Expense 8 Income before Tax \ 50 Tax Provision(20.0 percent effective tax rate) 10 Net Income \ 40 Total Assets \ 200 Accrued Liabilities \ 43 Long Temm Debt \ 80 Common Stock, at par \ 20 Retained Earnings (at the begiming of Year 1) \ 34 A. See the information for Simmons Company. Compute the amount of dividends you can assume that Simmons will pay in order to balance your projected balance sheet. Present the projected balance sheet. B. See the information for Simmons Company. Now assume that Simmons pays common shareholders a dividend of $25 in Year +1. Also assume that Simmons uses long-term debt as a flexible financial account, increasing borrowing when it needs capital and paying down debt when it generates excess capital. For simplicity, assume that Simmons pays 10.0 percent interest expense on the ending balance in long-term debt for the year and that interest expense is tax deductible at Simmons' average tax rate of 20.0 percent. Present the projected income statement and balance sheet for Year +1. (Hint: Because of the circularity between interest expense, net income, and debt, several iterations may be needed to balance the projected balance sheet and to have the projected balance sheet articulate with net income. You may find it helpful to program a spreadsheet to work the iterative computations.)

As a firm progresses through the decline life-cycle stage, what type of flexible account will it be more likely to use to balance the balance sheet?

To develop forecasts of individual assets, the analyst must first link historical growth rates for individual assets to historical growth rates in ____________________ and other activity-based drivers.

Hart designs, manufactures, and markets toys in domestic and international markets. Sales during 2010 totaled $4,022 million. Accounts receivable totaled $655 million at the beginning of 2010 and $612 million at the end of 2010. Required a. Use the average balance to compute the accounts receivable turnover ratio for Hart for 2010. b. Hart generated a compound annual sales growth rate of 13.0 percent over the past two years. Assume that Hart's sales will continue to grow at that rate each year for Year +1 through Year +5 and that the accounts receivable turnover ratio each year will equal the ratio computed in requirement a. for 2010. Project the amount of accounts receivable at year-end through Year +5 based on the accounts receivable turnover computed in requirement a. Also compute the percentage change in accounts receivable between each of the year-ends through Year +5. c. Does the pattern of growth in your projections of Hart's accounts receivable seem reasonable considering the assumptions of smooth growth in sales and steady turnover? Explain. d. The changes in accounts receivable computed in requirement b. display the sawtooth pattern depicted in Exhibit 10.5 in the text. Smooth the changes in accounts receivable by computing the year-end accounts receivable balances for Year 1 through Year 5 using the compound annual growth rate in accounts receivable between the end of 2010 and the end of Year +1 from requirement b. e. Smooth the changes in accounts receivable using the compound annual growth rate in accounts receivable between the end of 2010 and the end of Year +4 from requirement b. Apply this growth rate to compute accounts receivable at the end of Year +1 through Year +5. Why do the amounts for ending accounts receivable using the growth rate from requirement d. differ from those using the growth rate from this requirement? f. Compute the accounts receivable turnover for 2010 by dividing sales by the balance in accounts receivable at the end of 2010 (instead of using average accounts receivable as in requirement a). Use this accounts receivable turnover ratio to compute the projected balance in accounts receivable at the end of Year +1 through Year +5. Also compute the percentage change in accounts receivable between the year-ends for Year +1 through Year +5.

Financial statement forecasts should rely on ____________________ within financial statements.

Office Mart, Inc. sells numerous office supply products through a national distribution center. The company has focused on maintaining a cash balance equivalent to approximately 14 days of sales. Sales in 2010 amounted to $125,980,673 and the company expects growth in 2011 of 11% and in 2012 of 15%. Given this information determine Office Mart, Inc.'s projected year-end cash balance for 2011 and 2012.

It may be difficult to forecast sales for firms with _________________________ patterns because their historical growth rates reflect wide variations in both direction and amount from year to year.

Glad Rags, Inc. sells women's clothes. Provided below is selected financial statement information: Glad Rags, Inc. Selected Financial Statement data Fiscal year end 2010 2009 (amounts in thousands of dollers) Net sales \4 7,895 \4 2,589 Cost of Goods Sold Gross profit \1 1,943 \1 0,001 Inventory \5 ,548 \4 ,948 Required: a. Compute the inventory turnover ratio for 2010 . b. Clothes, Inc. projects that saleswill grow at a compound rate of $7 \%$ per year for years $2011-2013$ and that the cost of goods sold to sales percentage will equal that realized in 2010. Compute the projected implied level of inventory at the end of 2011 to 2013.

As a firm progresses through the introduction life-cycle stage, what type of flexible account will it be more likely to use to balance the balance sheet?

All of the following are true regarding the key principles of forecasting except:

Card Sharks, Inc. sells baseball cards and other memorabilia. The company tries to maintain a cash balance equivalent to approximately 30 days of sales. Sales in 2011 amounted to $352,412 and the company expects growth in 2012 of 33% and in 2013 of 40%. - Given the information provided about Card Sharks, what is the company's 2013 projected cash balance?