PROBLEMS

4-7 4-10

PRO FORMA INCOME

STATEMENT
At the end of last year, Roberts Inc. reported the following
income statement (in millions of dollars):
Sales

$3,000

Operating costs excluding depreciation

EBITDA
Depreciation
EBIT
Interest
EBT
Taxes (40%)
Net Income

$550
250
$300
125
$175
70
$105

2,450

Looking ahead to the following year, the companys CFO has

assembled this information:
Year-end sales are expected to be 10% higher than the $3
billion in sales generated last year.
Year-end operating costs, excluding depreciation, are
expected to equal 80% of year-end sales.
Depreciation is expected to increase at the same rate as
sales.
Interest costs are expected to remain unchanged.
The tax rate is expected to remain 40%.
On the basis of that information, what will be the forecast for
Roberts year-end net income?

ANSWER
Sales ($3,000 x 110%)
$3,300
Operating costs excluding depreciation
($3,300 x 80%)
2,640
EBITDA
Depreciation
EBIT
Interest
EBT
Taxes (40%)
Net Income

$660
($250 x 110%)
$385
125
$260
104
$156

275

LONG-TERM
FINANCING NEEDED
At year-end 2008, total assets for Ambrose Inc. were $1.2 million
and accounts payable were $375,000. Sales, which in 2008 were
$2.5 million, are expected to increase by 25% in 2009. Total
assets and accounts payable are proportional to sales, and that
relationship will be maintained. Ambrose typically uses no
current liabilities other than accounts payable. Common stock
amounted to $425,000 in 2008, and retained earnings were
$295,000. Ambrose plans to sell new common stock in the
amount of $75,000. The firms profit margin on sales is 6%; 60%
of earnings will be paid out as dividends.
a. What was Ambroses total debt in 2008?
b. How much new, long-term debt financing will be needed in
2008? (Hint: AFN New stock New long-term debt

ANSWER
A.

$1,200,000 = $375,000 + Long-term debt + $425,000 + $295,000

Long-term debt = $105,000.
Total debt = Accounts payable + Long-term debt
= $375,000 + $105,000 = $480,000.

B.
Assets/Sales (A*/S) = $1,200,000/$2,500,000 = 48%.
L*/Sales = $375,000/$2,500,000 = 15%.
2006 Sales = (1.25)($2,500,000) = $3,125,000.
AFN = (A*/S)(S) - (L*/S)(S) - MS1(1 - d) - New common
stock
= (0.48)($625,000) - (0.15)($625,000) - (0.06)($3,125,000)(0.6)
- $75,000
= $300,000 - $93,750 - $112,500 - $75,000 = $28,750.

SALES INCREASE
Pierce Furnishings generated $2 million in sales during 2008,
and its year-end total assets were $1.5 million. Also, at yearend, current liabilities were $500,000, consisting of $200,000
of notes payable, $200,000 of accounts payable, and
$100,000 of accrued liabilities. Looking ahead to 2009, the
company estimates that its assets must increase by $0.75 for
every $1.00 increase in sales. Pierces profit margin is 5%,
and its retention is 40%. How large of a sales increase can
the company achieve without having to raise funds
externally.

ANSWER
AFN = (A*/S0)S - (L*/S0)S - MS1(1 - d)
= (0.75)S - S -(0.05)(S1)(1 - 0.6)
= (0.75)S - (0.15)S - (0.02)S1
= (0.6)S - (0.02)S1
= 0.6(S1 - S0) - (0.02)S1
= 0.6(S1 - $2,000,000) - (0.02)S1
= 0.6S1 - $1,200,000 - 0.02S1
$1,200,000 = 0.58S1
$2,068,965.52 = S1.
Sales can increase by $2,068,965.52 - $2,000,000 = $68,965.52
without additional funds being needed.

REGRESSION
RECEIVABLES
Edward Industries has $320 million in sales. The company
expects that its sales will increase 12% this year. Edwards CFO
uses a simple linear regression to forecast the companys
receivables level for a given level of projected sales. On the basis
of recent history, the estimated relationship between receivables
and sales (in millions of dollars) is as follows:
Receivables= $9.25 + 0.07(Sales)
Given the estimated sales forecast and the estimated relationship
between receivables and sales, what are your forecasts of the
companys year-end balance for receivables and its year-end days
sales outstanding (DSO) ratio? Assume that DSO is calculated on
the basis of a 365-day a year.

ANSWER
YEAR END BALANCE OF RECEIVABLE
Sales= $320 x 1.12 = $358.4
Receivables= $9.25 + 0.07(Sales)
= $ 34.338
YEAR END DAYS SALES OUTSTANDING
DSO= 365/Sales/ Receivable
$358.4 = 365
$34.338

X= 34.97 or 35