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Microsoft Word - Document1 Assignment 04 – Forecasting and Short-Term Financial Planning Directions: Unless otherwise stated, answer in complete sentences, and be sure to use correct English spelling and grammar. Sources must be cited in APA format. Your response should be four (4) pages in length. Margins 1” all sides Paragraphs The entire document should be double-spaced on standard-sized paper (8.5" x 11") Headings Bold Type Style and Size Times New Roman, 12-point Software MS Word Respond to the items below. Part A: Cost of Debt Kenny Enterprises has just issued a bond with a par value of $1,000, twenty years to maturity, and an 8% coupon rate with semiannual payments. a. What is the cost of debt for Kenny Enterprises if the bond sells at the following prices? Show your work. 1. $920 2. $1,000 3. $1,080 4. $1,173 b. What do you notice about the price and cost of debt? Answer in complete sentences. Part B: Comparing NPV and IRR Chandler and Joey were having a discussion about which financial model to use for their new business. Chandler supports NPV, and Joey supports IRR. The discussion starts to get heated when Ross steps in and states, “Gentlemen, it doesn’t matter which method we choose, they give the same answer on all projects.” Ross is partially right, since NPV and IRR both reject or both accept the same projects under certain conditions. Explain under what three conditions NPV and IRR will be consistent when accepting or rejecting projects. Part C: Production Cash Outflow The Creative Products Corporation produces its products two months in advance of anticipated sales and ships to warehouse centers the month before sale. The inventory safety stock is 15% of the anticipated month’s sale. Beginning inventory in October 2017 was 120,000 units. Each unit costs $1.50 to make. The average selling price is $2.50 per unit. The cost is made up of 60% labor, 30% materials, and 10% shipping (to the warehouse). Labor is paid the month of production, raw materials the month prior to production, and shipping the month after production. Assume that the sales forecast for December 2017 is $2,500,000. What is the production cash outflow for the month of October 2017 production and in what months does each occur? Show your work and solve for 1. Cost of production 2. Labor cost 3. Shipping 4. Material cost Chapter 12.pdf Financial Management: Core Concepts Fourth Edition Chapter 12 Forecasting and Short-Term Financial Planning Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved. Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved. Learning Objectives 12.1 Understand the sources and uses of cash in building a cash budget. 12.2 Explain how companies use sales forecasts to predict cash inflow. 12.3 Understand how production costs vary in terms of cash flow timing. 12.4 Explain possible ways to cover cash deficits and invest cash surplus. 12.5 Prepare a pro forma income statement and a pro forma balance sheet. Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved. 12.1 Sources and Uses of Cash (1 of 3) • Cash is considered to be the life-blood of a business. Cash shortages can be stifling and expensive while excesses can lead to poor returns. • Since most businesses do not function on a pure cash basis, it is critical for them to forecast their needs for cash in advance. • The cash budget is the analytical tool that estimates the future timing of cash inflow and cash outflow and projects potential shortfalls and surpluses. Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved. 12.1 Sources and Uses of Cash (2 of 3) Table 12.1 Bridge Water Pumps and Filters, Cash Budget for First Six Months of 2018 ($ in Thousands) Despite setting up a cash reserve, the firm is projected to have cash shortfalls in 3 months and surpluses in 2 after all cash receipts and disbursements have been forecasted for the first half of 2018. Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved. 12.1 Sources and Uses of Cash (3 of 3) Figure 12.1 Cash inflows and cash outflows for a company. Identifying all possible sources and uses of cash is essential for preparing a useful cash budget. This list can serve as a guide when preparing a cash budget. Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved. 12.2 Cash Budgeting and the Sales Forecast (1 of 2) Sales revenue is the base variable driving almost all other items in the cash budget. Must forecast sales as objectively as possible. There is usually a time lag between when a sale is made and when the cash receipts come in → Must keep track of collections timeline. Need internal data (information that is proprietary or unique to the firm) as well as external data (publicly available information) sources for objective sales forecasts. Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved. 12.2 Cash Budgeting and the Sales Forecast (2 of 2) Figure 12.2 Marketing data for bridge water pumps and filters. Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved. 12.2 (A) Cash Inflow from Sales (1 of 2) • Firms typically sell products and services partially for cash and partially on credit. • An analysis of a firm’s collection policy can help project cash inflow from sales. • It is quite common for firms to collect some of their receivables in the 2 months following the sale, i.e. November 2017’s credit sales will be partially collected in December and January. Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved. 12.2 (A) Cash Inflow from Sales (2 of 2) Table 12.3 Bridge Water Pumps and Filters Cash Flow from Sales: January, February, and March 2018 Cash Flow Estimates Sales Nov. 2017 Dec. 2017 Jan. 2018 Feb. 2018 Mar. 2018 Forecasted sales 210 units 140 units 190 units 160 units 170 units Replacement (60%) $252,000 $168,000 $230,000 $192,000 $204,000 New home (40%) — — Blank Blank Blank Prior month (2/3) — $112,000 $74,000 $100,000 $86,000 Two months prior (1/3) — — $56,000 $38,000 $50,000 Total cash flow — — $360,000 $330,000 $340,000 Managers often figure in a small percentage of the forecasted sales as bad debts when preparing a cash budget. Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved. 12.2 (B) Other Cash Receipts • Besides sales, which are the main contributors to a firm’s cash inflow, need to forecast the timing and magnitude of other occasional sources of cash such as – asset sales, – funds raised through issuance and sale of securities, and – income earned on investments (dividends, interest, etc.). Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved. 12.3 Cash Outflow from Production The magnitude and timing of the various cash disbursements of a firm depends mainly on forecasted sales. – Payments for raw materials, labor costs, overheads such as utilities and rent, shipping costs, etc. Like sales, there is often a time lag between when the firm receives and records the benefit, and when it actually makes the payment for it. The cash budget can be used as a handy planning document to keep track of the projected disbursements. Depreciation is merely a tax write-off, not a cash disbursement, so should not be included in a cash budget. Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved. 12.4 The Cash Forecast: Short-Term Deficits and Short-Term Surpluses (1 of 2) The main objective of developing a cash budget → Firm has sufficient cash available from its revenues and other receipts to cover its periodic cash disbursements such as: 1. Accounts payables for materials and supplies; 2. Salaries, wages, taxes, other operating expenses; 3. Capital expenditures for plant, equipment, and machinery; and 4. Dividends, interest and floatation cost payments related to raising and servicing of capital. Over a short planning cycle, the total periodic cash inflow rarely matches the total periodic outflow → seasonal fluctuations and time lags. → Forecasted cash deficits and surpluses in certain periods Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved. 12.4 The Cash Forecast: Short-Term Deficits and Short-Term Surpluses (2 of 2) Table 12.4 Monthly Cash Budget for Bridge Water Pumps and Filters Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved. 12.4 (A) Funding Cash Deficits Cash shortfalls can be handled in four ways: 1. Cash from savings. 2. Unsecured loans (letters of credit). 3. Secured loans (using accounts receivable or inventories). 4. Other sources (commercial paper, trade credit, or banker’s acceptance). Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved. 12.4 (B) Investing Cash Surpluses When a company has excess funds, it has four options: 1. Put the surplus in a savings account or invest it in marketable securities. 2. Repay lenders and owners (retire debt early or pay extra dividends). 3. Replace aging assets. 4. Invest in the company, accepting positive net present value projects. Copyright © 2019, 2016, 2013 Pearson Education, Inc. All Rights Reserved. 12.5 Planning with Pro Forma Financial Statements (1 of 2) • Cash budgeting is only one aspect of short-term financial planning. Equally important for firms to forecast their operating cash flow and net income for the forthcoming period by developing pro forma financial statements. • There are a variety of ways to produce pro forma statements, but the statements usually rely on two primary inputs: – The prior year’s financial statements and the relationship of the account balances to each other, and – The projected sales for the coming year.