The CEO of North American Manufacturing Company has asked you to (a) complete th
ID: 2774155 • Letter: T
Question
The CEO of North American Manufacturing Company has asked you to (a) complete the projected income statement and projected balance sheet for the coming fiscal year (FY) of the company using the information set forth below. She has also asked you to (b) determine the amount of any additional external financing the company will require during the coming fiscal year and (c) assess the reasonableness of the projections in relation to the company’s estimated cost of equity capital, rE, and its sustainable sales growth rate.
Use the average gross margin during the preceding two-year period to project the amount of gross profit.
Use the average ratio of "all other S&A-to-sales revenue" during the preceding two-year period to project the amount of all other S&A expense.
Use the average amount of R&D expense during the two preceding FYs to project the amount of this expense.
The estimated combined effective income tax rate during the projected FY is 0.40 (40.0 percent).
Project the balances of cash and cash equivalents, total current assets, and total liabilities as “residual amounts” using the general methodology examined in Topic 9 of the course. Project total assets using the projected balance of total liabilities and shareholders' equity. Project the balance of total liabilities and stockholders' equity based on projected total stockholders' equity and a targeted total debt ratio (ratio of total liabilities-to-total stockholders' equity) of 0.70 (70 percent).
Project the balance of accounts receivable (AR) using a projected average AR collection period ratio of 45 days.
Project the balance of inventory using a projected average days to sell inventory ratio of 90 days.
Project the balance of other assets using the average balance of this item during the two preceding FYs.
Project the balance of accounts payable (AP) using projected "cash costs" and a projected average AP payment period of 45 days. "Cash costs" include projected COGS and operating expenses, excluding depreciation.
Project the balance of dividends payable as the dividends that the company expects to declare during the final week of the projected FY (based on net income for that year) and pay early in the next FY. The company's payout ratio (dividend policy) is 0.40 (40 percent).
The company plans no issuances (or repurchases) of common stock during the projected FY.
Project retained earnings (RE) using projected net income and projected dividends to be declared near the end of the projected FY.
The company’s estimated cost of equity capital, rE, is 0.227 (22.7 percent), computed using CAPM as: rF + x (rM – rF) = 0.04 + 2.2 x (0.125 – 0.04)
Continued
Continued
a. Projected income statement
Actual (historical)
Projected
Computational Notes
20X0
20X1
20X2
(Formulas or equations used)
(A)
Sales revenue
$48,500,000
50,900,000
$ 55,000,000
Given
Cost of goods sold (COGS):
(B)
Deprec. of manufacturing PP&E
6,695,000
6,985,000
7,300,000
Given
(C)
All other COGS
25,800,000
26,100,000
29000000
=36300000-7300000
(D)
Total COGS
32,495,000
33,085,000
36300000
=55000000-18700000
(E)
Gross profit
$ 16,005,000
17,815,000
18700000
=55000000*34.0%
(F)
Gross margin
33.0%
35.0%
34.0%
=33.0+35.0/2
Operating expenses:
Selling and admin. (S&A) exp.:
(G)
Deprec. of non-mfg PP&E
$ 360,000
520,000
$ 700,000
Given
(H)
All other S&A expense
5,820,000
6,108,000
5964000
=5820000+6108000/2
(I)
Research and devel. (R&D) exp.
1,290,000
1,510,000
1400000
=1290000+1510000/2
(J)
Other operating expenses
135,000
177,000
200,000
Given
(K)
Total operating expenses
7,605,000
8,315,000
8,264,000
=SUM(G:J)20x2
(L)
Operating income
8,400,000
9,500,000
10436000
=18700000-8264000
(M)
Interest on debt
(660,000)
(750,000)
(810,000)
Given
(N)
Income from investments
10,000
10,000
10,000
Given
(O)
Gain (loss) on PP&E disposals
-
(94,000)
-
Given
(P)
Income before taxes
7,750,000
8,666,000
9636000
=10436000+(810000)+100000
(Q)
Provision for income taxes
3,100,000
3,466,000
3854400
=9636000*.40
(R)
Net income
$ 4,650,000
5,200,000
5781600
=9636000-3854400
Continued
Continued
a. (continued) Projected balance sheet
Assets:
Actual (historical)
Projected
Computational Notes
Current assets:
20X0
20X1
20X2
(Formulas or equations used)
(A)
Cash and cash equivalents
$ 450,000
690,000
????
(B)
Investment securities
200,000
200,000
200,000
Given
(C)
Accounts receivable
6,060,000
6,360,000
(D)
Inventory
8,120,000
8,270,000
(E)
Total current assets
14,830,000
15,520,000
Current ratio (working capital) ratio
1.0
1.0
(F)
PP&E, at cost
38,510,000
45,790,000
53,800,000
Given
(G)
Accumulated depreciation of PP&E
14,260,000
20,340,000
26,300,000
Given
(H)
PP&E, net
24,250,000
25,450,000
(I)
Other assets
600,000
900,000
(J)
Total assets
$ 39,680,000
41,870,000
Liabilities:
Current liabilities:
(K)
Accounts payable
$ 4,130,000
4,240,000
(L)
Accrued income taxes payable
780,000
870,000
900,000
Given
(M)
Dividends payable
1,860,000
2,080,000
(N)
Bank notes payable – current
7,800,000
8,000,000
8,800,000
Given
(O)
Accrued interest payable
170,000
190,000
200,000
Given
(P)
Total current liabilities
14,740,000
15,380,000
(Q)
Bank notes payable – noncurrent
4,800,000
3,230,000
(R)
Total liabilities
19,540,000
18,610,000
Total debt ratio
0.97
0.80
Stockholders' equity:
(S)
Common stock, at par
12,500,000
12,500,000
12500000
Same as previous years
(T)
Additional paid-in capital
2,600,000
2,600,000
2600000
Same as previous years
(U)
Retained earnings
5,040,000
8,160,000
????
(V)
Total stockholders' equity
20,140,000
23,260,000
(W)
Total liab. and stockhldrs' equity
$ 39,680,000
41,870,000
Continued
Continued
b. Determine the amount of any additional external financing the company will require during the coming FY. Show computations in good form and label properly all amounts presented.
c. Assess the reasonableness of the projected financial statements in relation to the company’s estimated cost of equity capital, rE, and its sustainable sales growth rate.
Actual (historical)
Projected
20X0
20X1
20X2
Return on average common equity (ROCE) ratio
24.8%
24.0%
% ????
Net income (available to common stockholders)
$ 4,650,000
5,200,000
$ ????
Total stockholders' equity, beginning of FY
17,350,000
20,140,000
$ ????
Total stockholders' equity, end of FY
20,140,000
23,260,000
$ ????
Average total stockholders' equity
$ 18,745,000
21,700,000
$ ????
Sustainable rate of sales growth
% ????
Net income (available to common stockholders)
$ ????
Beginning-of-year shareholders’ equity
$ ????
Payout ratio
% ????
Assessment of projected ROCE and sustainable growth rate in sales ratios (limit your response to a maximum of 100 words):
Replace this text with your analysis.
a. Projected income statement
Actual (historical)
Projected
Computational Notes
20X0
20X1
20X2
(Formulas or equations used)
(A)
Sales revenue
$48,500,000
50,900,000
$ 55,000,000
Given
Cost of goods sold (COGS):
(B)
Deprec. of manufacturing PP&E
6,695,000
6,985,000
7,300,000
Given
(C)
All other COGS
25,800,000
26,100,000
29000000
=36300000-7300000
(D)
Total COGS
32,495,000
33,085,000
36300000
=55000000-18700000
(E)
Gross profit
$ 16,005,000
17,815,000
18700000
=55000000*34.0%
(F)
Gross margin
33.0%
35.0%
34.0%
=33.0+35.0/2
Operating expenses:
Selling and admin. (S&A) exp.:
(G)
Deprec. of non-mfg PP&E
$ 360,000
520,000
$ 700,000
Given
(H)
All other S&A expense
5,820,000
6,108,000
5964000
=5820000+6108000/2
(I)
Research and devel. (R&D) exp.
1,290,000
1,510,000
1400000
=1290000+1510000/2
(J)
Other operating expenses
135,000
177,000
200,000
Given
(K)
Total operating expenses
7,605,000
8,315,000
8,264,000
=SUM(G:J)20x2
(L)
Operating income
8,400,000
9,500,000
10436000
=18700000-8264000
(M)
Interest on debt
(660,000)
(750,000)
(810,000)
Given
(N)
Income from investments
10,000
10,000
10,000
Given
(O)
Gain (loss) on PP&E disposals
-
(94,000)
-
Given
(P)
Income before taxes
7,750,000
8,666,000
9636000
=10436000+(810000)+100000
(Q)
Provision for income taxes
3,100,000
3,466,000
3854400
=9636000*.40
(R)
Net income
$ 4,650,000
5,200,000
5781600
=9636000-3854400
Explanation / Answer
Projected Income Statement Actual Projected Computational Notes 20x0 20x1 20x2 Sales Revenue 48500000 50900000 55000000 Given Cost of Goods Sold Depreciation of Manufacturing PP & E 6695000 6985000 7300000 Given All other Cost of Good Sold 25800000 26100000 29000000 36300000-7300000 Total Cost of Goods Sold 32495000 33085000 36300000 55000000-18700000 Gross Profit 16005000 17815000 18700000 55000000*34% Gross Profit Margin 33 35 34 (33+35)/2 Operating Expenses Depreciation of non-Mfg PP&E 360000 520000 700000 Given All other S & A Expenses 5820000 6108000 5964000 (582000+6108000)/2 R & D Expenses 1290000 1510000 1400000 (1290000+1510000)/2 Other operating Expenses 135000 177000 200000 Given Total Operating Expenses 7605000 8315000 8264000 (G+H+I+J) Operating Income 8400000 9500000 10436000 (E-K) Interest on Debt -660000 -750000 -810000 Given Income from Investments 10000 10000 10000 Given Gain (loss) on PP&E Disposals 0 -94000 0 Given Income before Taxes 7750000 8666000 9636000 (L+M+N+O) Provision for Income Tax 3100000 3466400 3854400 P*40% Net Income 4650000 5199600 5781600 (P-Q) Projected Balance Sheet Assets Actual Projected Computational Notes 20x0 20x1 20x2 Current Assets Cash and Cash Equivalents 450000 690000 1257725 (E-B-C-D) Investment Securities 200000 200000 200000 Given Accounts Receivable 6060000 6360000 6780822 (Sales/365*45) Inventory 8120000 8270000 8950685 (COGS/365*90) Total Current Assets 14830000 15520000 17189232 (K-J-I) Current Ratio (working capital ratio) PP & E, at cost 38510000 45790000 53800000 Given Accumulated Depreciation 14260000 20340000 26300000 Given PP & E, net 24250000 25450000 27500000 Other Assets 600000 900000 750000 (600000+900000)/2 Total Assets 39680000 41870000 45439232 Equal to W for projected Values Liabilities Current Liabilities Accounts Payable 4130000 4240000 4594192 (G+K-B of income stmt)/365*45 days Accrued Income Taxes payable 780000 870000 900000 Given Dividends Payable 1860000 2080000 2312640 (R in Income stmt * 0.40) Bank Notes Payable - current 7800000 8000000 8800000 Given Accrued Interest Payable 170000 190000 200000 Given Total Current Liabilities 14740000 15380000 16806831.78 (K+L+M+N+O) Bank Notes Payable - Non-current 4800000 3230000 1903440.219 R-P Total Liabilities 19540000 18610000 18710272 V*0.70 for projected value Total Debt Ratio 0.97 0.8 0.7 Given as targeted ratio Stockholder's Equity Common Stock, at par 12500000 12500000 12500000 Same as previous years Additional Paid-in Capital 2600000 2600000 2600000 Same as previous years Retained Earnings 5040000 8160000 11628960 previous RE +Net Income - Dividends Total Stockholder's Equity 20140000 23260000 26728960 (S+T+U) Total Liabilities & Stock Holders Equity 39680000 41870000 45439232 (R+V) External Fund Requirement Calculation EFN can be calculated using the formula A/S * (S1-S) - L/S (S1-S) - PM*b*S1 where A = Assets in year 0 S = Sales in Year 0, S1 = Expected Sales L = Liabilities which vary with sales in Year 0 PM = Net Income/Sales, b = retention Ratio Liabilities which vary with sales are Accounts Payable Given S1 55000000 A/S 0.804911591 L/S 0.083300589 PM 0.102153242 b 0.6 S 50900000 External Fund Requirement EFN = -412451.8664 External Fund requirement is coming as Negative value 412452 which is adjusted in Bank Notes payable - noncurrent Reseaonableness of Projected Financials in relation to company's estimated cost of equity rE and its sustainable growth rate Actual Projected 20x0 20x1 20x2 Return on Average Common Equity 24.80% 24% 23.13% Net Income 4650000 5199600 5781600 Total Stockholders Equity Beginning 17350000 20140000 23260000 Total Stockholders Equity Ending 20140000 23260000 26728960 Average Total Stockholders Equity 18745000 21700000 24994480 Sustainable Sales Growth Rate ROE (1-dividend payout) 14.91 Net Income available to Common Equity Stock Holders 5781600 Beginning of the Year Equity 23260000 Pay out Ratio 0.4 Sustainable growth rate based on cost of equity = 22.7% * (1-0.40) 13.62 The Return on average common equity based on projections is 23.13% vis-à-vis estimated figure of 22.7%. Also the sustainable growth rate in sales based on projections is 14.91% compared to 13.62% based on the rE figure. As there is not much divergence between projected figures and the those derived basedon rEfigures, the projections given are sustainable.
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