It is also known that the firm s assets have been operating at full capacity

It is also known that the firm s assets have been

This preview shows page 58 - 62 out of 146 pages.

dividend pay-out ratio is 60%. It is also known that the firm s assets have been operating at full capacity. During the same year, Blue Nile s operating costs were Br. 1,620,000
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59 and are estimated to increase proportionately with sales. Assume the companys interest expense will be Br. 40,000 during the next year and its tax rate is 40%. Required:Determine the additional funds needed (AFN) of Blue Nile Share Company for the next year using the proforma financial statements method. Solution First, we develop the proforma income statement Pro Forma Income Statement ____________________________________________________________________________________________________________ Sales (Br. 1,800,000 x 1.10) ------------------------------------------------------------------------------Br. 1,980,000 Operating costs (Br. 1,620,000 x 1.10) ----------------------------------------------------------------------1,782,000Earnings before interest and taxes (EBIT) ----------------------------------------------------------------Br. 198,000 Interest expense -----------------------------------------------------------------------------------------------------40,000Earnings before taxes (EBT) --------------------------------------------------------------------------------Br. 158,000 Taxes (Br. 158,000 x 40%) ---------------------------------------------------------------------------------------63,200Net income -----------------------------------------------------------------------------------------------------Br. 94,800Dividends to common stock (Br. 94,800 x 60%) ---------------------------------------------------------Br. 56,880Addition to retained earnings (Br. 94,800 Br. 56,880) ------------------------------------------------Br. 37,920Then, we construct the proforma balance sheet Pro Forma Balance Sheet ____________________________________________________________________________________________________________ Assets Liabilities and Equity Cash (Br. 10,000 x 1.10) ----------------Br. 11,000 A/Payable (Br. 90,000 x 1.10) -------------Br. 99,000 A./receivable (Br. 70,000 x 1.10) ----------77,000 Accruals (Br. 40,000 x 1.10) --------------------44,000Inventories (Br. 150,000 x 1.10) ----------165,000Current liabilities ----------------------------Br. 143,000 Current assets ---------------------------Br. 253,000 Long-term debt (the increase is unknown)----200,000 Net fixed assets (Br. 370,000 x 1.10) ----407,000 Common stock (as long-term debt) ------------120,000 _______ Retained earnings (Br. 150,000 + Br. 37,920) 187,920Total assets -----------------------Br. 660,000Total liabilities and equity -------------Br. 650,920Blue Niles forecasted total assets as shown above are Br. 660,000. However, the forecasted total liabilities and equity amount to only Br. 650,920. Since the balance sheet must balance, i.e. A = L + OE, the difference must be covered by additional funds. Therefore, AFN = Br. 660,000 Br. 650,920 = Br. 9,080.
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60 1. Briefly explain why an accurate financial forecast is crucial to the wealth maximization goal of a firm. ________________________________________________________________________ ________________________________________________________________________ ________________________________________________________________________ 2. In the illustration above, the amount of interest expense is assumed to be Br. 40,000. What do you think are the basic factors that affect the amount of interest expense? ________________________________________________________________________________________________________________________________________________________________________________________________________________________ 3. Taha Private Limited Company (PLC) had sales of Br. 5 million and total assets of Br. 4.5 million in 2002. The current liabilities during the end of the same year were Br. 1,250,000. The PLC s net profit margin and dividend pay-out ratios are 6% and 30% respectively. All assets and current liabilities will vary directly with sales. Determine the additional funds needed (AFN) for 2003 if sales are projected to grow by 5% only. ________________________________________________________________________ ________________________________________________________________________ ________________________________________________________________________
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61 4.4.2 The Formula Method This is a much easier method of determining additional financial requirements than the pro forma method. The formula method is a shortcut to financial forecasting. However, many companies use the pro forma method of forecasting their financial requirements because the output of the formula method is less meaningful. Under the shortcut method, we make the following assumptions.
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