Question 1

Benson sells books through retail stores and on the Web.For a retailer like Benson,inventory is a critical element of the business and it is necessary to carry a wide array of titles.In 2010,sales totaled $5,122 million and cost of sales and occupancy totaled $3,541 million.Inventories constitute the largest asset on Benson's balance sheet,totaling $1,203 million at the end of 2010 and $1,358 million at the end of 2009.
Required
a.Compute the inventory turnover ratio for Benson for 2010.
b.Over the last two years,the number of Benson retail stores has remained fairly steady and sales have grown at a compounded annual rate of 11.6 percent.Assume that the number of stores will remain constant and that sales will continue to grow at an annual rate of 11.6 percent each year between Year +1 and Year +5.Also assume that the future cost of goods sold to sales percentage will equal that realized in 2010 (which is very similar to the cost of goods sold percentage over the past three years).Project the amount of inventory at the end of Year +1 through Year +5 using the inventory turnover ratio computed in Part a.Also compute the percentage change in inventories between each of the year-ends between 2010 and Year +5.Does the pattern of growth in your projections of Benson inventory seem reasonable to you considering the assumptions of smooth growth in sales and steady cost of goods sold percentages? Explain.
c.The changes in inventories in Part b display the sawtooth pattern depicted in Exhibit 10.5 of the text.Smooth the changes in the inventory forecasts between 2010 and Year +5 using the compound annual growth rate in inventories between the end of 2010 and the end of Year +5 implied by the projections in Part b.Does this pattern of growth seem more reasonable? Explain.
d.Now suppose that instead of following the smoothing approach in Part c,you used the rate of growth in inventory during 2010 to project future inventory balances at the end of Year +1 through Year +5.Use these projections to compute the implied inventory turnover rates.Does this pattern of growth and efficiency in inventory for Benson seem reasonable? Explain.

Accepted Answer

$\text { (Assume Amounts in Thousands). }$
$\text { a. Benson inventory turnover: } \$ 3,541 /[.5(\$ 1,358+\$ 1,203)]=2.77$

b.
$\begin{array}{lllllllll}
&\text { Cost of}&&&&\text { Inventories}&\text { Percentage}\
&\text { Goods } & \text { Inventory } & \text { Average } & \text { Beginning } & \text { End of } & \text { Change in } \
&\text { Sold } & \text { Turnover } & \text { Inventories } & \text { of Year } & \text { Year } & \text { Inventories }\
\text { Year }+1 & \$ 3,952 & 2.77 & \$ 1,427 & \$ 1,203 &  \$ 1,655 & +37.6 \% \
\text { Year }+2 & \$ 4,410 & 2.77 & \$ 1,595 & \$  1,655 & \$ 1,535 & -7.3 \% \
\text { Year }+3 & \$ 4,922 & 2.77 & \$ 1,780 & \$  1,535 & \$  2,025 & +32.0 \% \
\text { Year }+4 & \$ 5,493 & 2.77 & \$ 1,986 & \$  2,025 &  \$ 1,947&-3.8 \% \
\text { Year }+5 & \$ 6,130 & 2.77 & \$ 2,217 & \$ 1,947 &  \$ 2,486 & +27.6 \%
\end{array}$
These projections exhibit substantial volatility in ending inventory, which is unrealistic considering the assumptions of smooth growth in sales and costs of sales.

c. The above projections indicate an increase in inventories from $ \$ 1,203 $ to $ \$ 2,486 $ over five years, representing a compound annual rate of growth of $ 15.62 $ percent [= $ \left.(\$ 2,486 / \$ 1,203)^{\wedge}(1 / 5)-1\right] . $

$\begin{array}{ll}
&\text { Ending Inventories }\
\text { Year }+1 & \$ 1,203 \times 1.1562=\$ 1,391 \
\text { Year }+2 & \$ 1,391 \times 1.1562=\$ 1,608 \
\text { Year }+3 & \$ 1,608 \times 1.1562=\$ 1,859 \
\text { Year }+4 & \$ 1,859 \times 1.1562=\$ 2,150
\end{array}$ 
 $ \quad $$ \quad $$ \quad $$ \quad $$ \quad $$ \quad $$ \quad $$ \quad $$ \quad $$ \quad $Year $ +5 $ $ \quad\quad\quad\$ 2,150 \times 1.1562=\$ 2,486 $
These smoothed inventory forecasts more closely match the assumptions of smooth growth in sales and costs of goods sold.
d. Benson inventories actually decreased from $ \$ 1,358 $ at the end of 2009 to $ \$ 1,203 $ at the end of 2010 , a decline of $ 11.4 $ percent. Using this growth rate leads to the following projections of inventories and implied turnover rates:
$\begin{array}{rrrll}
&\text { Ending Inventories }&\text { Implied Turnover }\
\text { Year }+1 & \$ 1,203 \times 0.886=  \$ 1,066 & \$ 3,952 /[(\$ 1,203+\$ 1,066) / 2] & =3.48 \
\text { Year }+2 & \$ 1,066 \times 0.886=  \$ 944 & \$ 4,410 /[(\$ 1,066+\$ 944) / 2] & =4.39 \
\text { Year }+3 & \$ 944 \times 0.886= \$ 836 & \$ 4,922 /[(\$ 944+\$ 836) / 2] & =5.53 \
\text { Year }+4 & \$ 836 \times 0.886=  \$ 741 & \$ 5,493 /[(\$ 836+\$ 741) / 2] & =6.97 \
\text { Year }+5 & \$ 741 \times 0.886=  \$ 656 & \$ 6,130 /[(\$ 741+\$ 656) / 2] & =8.77
\end{array}$

This problem demonstrates that simply assuming that past growth rates will persist can lead to unreasonable forecasts. In this case, it is highly unlikely that Benson can continue to decrease inventory while at the same time generating an increase in sales. It would be very unusual for a retail bookstore such as Benson to be able to achieve $ 8.77 $ inventory turns a year by Year $ +5 $

Question 2

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.

Accepted Answer

$\begin{array}{lcrr}
&\text { Annual } & \text { Average } & \text { Days Sales } & \text { Year-end } \
&\text { Sales } & \text { Sales/Day } & \text { in Cash } & \text { Cash Bal } \
\hline
2010&\$ 125,980,673 & \text { Sales/365 } & \text { Given } & \text { Sales/Day *14 } \
2011&\$ 139,838,547 & 383,119 & 14 & \$ 5,363,670 \
2012&\$ 160.814 .329 & 440.587 & 14 & \$ 6.168,221
\end{array}$

Question 3

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:

Accepted Answer

A)   the percentage change in cost of goods sold in prior years is significantly greater than the percentage change in sales.
B)   the percentage change in cost of goods sold in prior years is significantly less than the percentage change in sales.
C)   low capital intensity in the production process.
D)   the percentage change in sales in prior years is significantly greater than the percentage change in receivables. B

Question 4

Projecting sales price changes depends on factors specific to the firm and its industry that might affect demand and price elasticity.Which of the following types of companies would most likely be able to increase prices?

Accepted Answer

A)   A firm in a capital intensive industry that is expected to operate near capacity for the near future.
B)   A firm in a capital intensive industry in which excess capacity exists.
C)   A firm operating in an industry that is expected to experience technological improvements in its production process.
D)   A firm operating in an industry that is transitioning from the high growth to the maturity phase of its life cycle.

Question 5

Sparky's
Sparky's sells auto parts.Provided below is selected financial information from the company's 2012 annual report:
 $\begin{array} { l r r } 
\text { Fiscalyear end } & 2012 & 2011 \
\text { (amounts in thousands of dollars) } & & \
\text { Net sales } & \$ 125,410 & \$ 106,380 \
\text { Cast of Goods Sold } & - 104,090 & -  8 9 , 3 5 5  \
\text { Grass Prafit } & \$ 21,320 & \$ 17,021 \
\text { Irventory } & \$ 31,353 & \$ 30,850
\end{array}$
-Using Sparky's financial information what is the company's inventory turnover ratio for 2012?

Accepted Answer

A)   0.69
B)   1.00
C)   3.35
D)   4.03

Question 6

Projected financial statements can be used to assess the sensitivity of all of the following except:

Accepted Answer

A)   a firm's liquidity.
B)   a firm's leverage to changes in assumptions.
C)   conditions under which the firm's debt covenants may become binding.
D)   unusual patterns for projected total assets.

Question 7

The first step in the forecasting game plan is to project sales and other operating activities.Sales numbers are determined by both a volume component and price component.Projecting prices depends on factors specific to the firm and its industry that might affect demand and price elasticity.For the following types of firms,discuss whether it would be likely that the firm would be able to raise future prices:
a.A firm in a capital-intensive industry that is expected to operate near capacity for the near future.
b.A firm in an industry that is expected to experience numerous technological improvements.
c.A firm with products that are transitioning from the growth to maturity phase of the product life cycle.
d.A firm that has established a well-known brand name and image.

Accepted Answer

The answer of The first step in the forecasting game...

Question 8

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 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.

Accepted Answer

The answer of Hart designs,manufactures,and markets toys in domestic and...

Question 9

Repair Specialists is a leading retailer of home improvement products.It operates large warehouse-style stores.Despite declining sales and difficult economic conditions in 2009 and 2010,Repair Specialists continued to invest in new stores.The following table provides summary data for Repair Specialists.
 $\begin{array} { | l | r | r |} 
\hline \begin{array} { l } 
\text { Repair specinlists } \
\text { (ampunts in millians except number of } \
\text { stures) }
\end{array} & \mathbf { 2 0 0 9 } &  \text { 2010 }  \
\hline \text { Number af stares } & 2,234 & 2,274 \
\hline \text { Sales revenues } & \$ 7,349 & \$ 71,288 \
\hline \text { Inventary } & \$ 11,71 & \$ 10,673 \
\hline \text { Capital expenditures, net } & \$ 3,558 & \$ 1,847 \
\hline
\end{array}$ 
Required
a.Use the preceding data for Repair Specialists to compute average revenues per store,
capital spending per new store,and ending inventory per store in 2010.
b.Assume that Repair Specialists will add 100 new stores by the end of Year 1.Use
the data from 2010 to project Year 1 sales revenues,capital spending,and ending
inventory.Assume that each new store will be open for business for an average of
one-half year in Year 1.For simplicity,assume that in Year 1,Repair Specialists' sales
revenues will grow,but only because it will open new stores.

Accepted Answer

The answer of Repair Specialists is a leading retailer of...

Question 10

As an analyst it is important when projecting sales to make estimates about future changes in sales volume.Compare how you might make estimates about future sales value for a company in a mature industry and one in a rapidly growing industry.

Accepted Answer

The answer of As an analyst it is important when...

Question 11

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:

Accepted Answer

A)   the cash collections from sales in the projected income statement.
B)   the cash provided by or used by operations on the projected statement of cash flows.
C)   the net change in cash on the projected statement of cash flows.
D)   the net change in working capital from period to period.

Question 12

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.

Accepted Answer

The answer of To develop forecasts of individual assets,the analyst...

Question 13

Simmons Company
These data represent a summary of your first-iteration forecast amounts for Year 1.Simmons uses dividends as a flexible financial account.
 $\begin{array}{|l|r|}
\hline&\text { Year +1 }\
\hline \text { Operating Income } & \$ 58 \
\hline \text { Interest Expense } & 8 \
\hline \text { Income before Tax } & \$ 50 \
\hline \text { Tax Provision (20.0 percent effective tax rate) } & 10 \
\hline \text { Net Income } & \$ 40 \
\hline \text { Total Assets } & \$ 200 \
\hline \text { Accrued Liabilities } & \$ 43 \
\hline \text { Long-Term Debt } & \$ 80 \
\hline \text { Common Stock, at par } & \$ 20 \
\hline \text { Retained Earnings (at the beginning of Year } 1 \text { ) } & \$ 34\
\hline
\end{array}$ 
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.)

Accepted Answer

The answer of Simmons Company
These data represent a summary of...

Question 14

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?

Accepted Answer

A)   issued debt
B)   growth related assets
C)   issued equity
D)   stock buy-backs

Question 15

Projecting sales price changes depends on factors specific to the firm and its industry that might affect demand and price elasticity.Which of the following companies would most likely not be able to increase prices in the near future?

Accepted Answer

A)   A firm in a capital intensive industry that is expected to operate near capacity for the near future.
B)   A firm in a capital intensive industry in which excess capacity exists.
C)   A firm operating in an industry that is expected to maintain its current production processes.
D)   A firm operating in an industry that is transitioning from the introduction phase to the high growth phase of its life cycle.

Question 16

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.
 $\begin{array}{|l|r|r|}
\hline \text { Aamounts in millions) } & \text { Year 3 } & \text { Year 4 } \
\hline \text { Arco } & & \
\hline \text { Sales } & \$ 4,042 & \$ 5,217 \
\hline \text { Cost of Products Sold } & 3,887 & 4,554 \
\hline \text { Gross Profit } & \$ 155 & \$ 663 \
\hline \text { Gross Margin } & 3.8 \% & 12.7 \% \
\hline & & \
\hline \text { Nuwak } & & \
\hline \text { Sales } & \$ 6,266 & \$ 11,377 \
\hline \text { Cost of Products Sold } & 5,997 & 9,129 \
\hline \text { Gross Profit } & \$ 269 & \$ 2,248 \
\hline \text { Gross Margin } & 4.3 \% & 19.8 \%\
\hline
\end{array}$ 
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?

Accepted Answer

The answer of Arco is an integrated manufacturer in capital-intensive...

Question 17

Techtronics is a leader in manufacturing computer chips,which is very capital-intensive.Because the production processes in computer chip manufacturing require sophisticated and rapidly changing technology,production and manufacturing assets in the chip industry tend to have relatively short useful lives.
The following summary information relates to Techtronics' property,plant,and
equipment for 2009 and 2010:
 $\begin{array}{|l|r|r|}
\hline \text { Techtronics (amounts in millions) } & \text { 2009 }&  \text { 2010 }\
\hline \text { Property, Plant, and Equipment, at cost } & \$ 46,052 &\$ 48,088\
\hline \text { Accumulated Depreciation } & \$(29,134)& \$(30,544) \
\hline \text { Property, Plant, and Equipment, net } & \$ 16,918& \$ 17,544  \
\hline \text { Depreciation Expense } && \$ 4,360 \
\hline \text { Cavital Expenditures. net } && \$ 5,200\
\hline
\end{array}$ 
Required
Assume that Techtronics depreciates all property,plant,and equipment using the straight-line
depreciation method and zero salvage value.Assume that Intel spends $6,000 on new
depreciable assets in Year 1 and does not sell or retire any property,plant,and equipment
during Year 1.
a.Compute the average useful life that Techtronics used for depreciation in 2010.
b.Project total depreciation expense for Year 1 using the following steps: (i)project
depreciation expense for Year 1 on existing property,plant,and equipment at the
end of 2010; (ii)project depreciation expense on capital expenditures in Year 1
assuming that Intel takes a full year of depreciation in the first year of service; and
(iii)sum the results of (i)and (ii)to obtain total depreciation expense for Year 1.
c.Project the Year 1 ending balance in property,plant,and equipment,both at cost
and net of accumulated depreciation

Accepted Answer

The answer of Techtronics is a leader in manufacturing computer...

Question 18

The authors set forth a seven-step forecasting game plan for preparing pro forma financial statements.Discuss the seven steps necessary to prepare the three principal financial statements.

Accepted Answer

The answer of The authors set forth a seven-step forecasting...

Question 19

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

Accepted Answer

The answer of Analysts must develop realistic expectations for the...

Question 20

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

Accepted Answer

A)   The statement of cash flows is the most critical forecast since it reflects profitability rather than viability.
B)   Preparing projected financial statements must incorporate a company's past performance records.
C)   Preparing projected financial statements must incorporate a company's current performance records.
D)   The income statement demonstrates immediate capability to service debt for banks or real potential for growth in returns for venture capital.

Exam 10: Forecasting Financial Statements