Questions Set 79: Solution


Financial Forecasting

As a financial analyst of, you need to prepare pro forma financial statements for 2012. has the following balance sheet as of December 31, 2011 ($ millions).

Cash                                        $    3.5             Accounts payable                    $    9.0
Receivables                                 26.0             Notes payable                              18.0
Inventory                                     58.0             Accruals                                        8.5
Total current assets               $  87.5                Total current liabilities          $   35.5
Net fixed assets                                       35.0             Mortgage loan                                6.0
Common stock                                        15.0
Retained earnings                        66.0
Total Assets                          $122.5                Total Liab. & Capital                        $122.5
=====                                                              ======

In 2011, had sales of $350 million, net income of $10.5 million, and paid dividends of $4.2 million to common stockholders.  The firm has been operating at full capacity.  Assume that all ratios remain constant.

For the year 2012, projects its sales to be $420 million (an increase of $70 million).  (1) Use the AFN general formula to compute the projected additional funds needed (AFN) for 2012; (2) What does your estimated AFN figure tell you about’s financing to support the sales increase in 2012?

Short-Term Financing Choices

Falcon Ski Company estimates that for the next quarter there is a 60% probability that it will have a $2 million cash deficit, and a 40% probability that it will have no deficit at all.  The company can either (1) take out a 90-day unsecured loan at an interest rate of 1% per month or (2) establish a line of credit, costing an interest rate of 1% per month on the amount borrowed plus a commitment fee of $15,000.  Both alternatives also require a 20% compensating balance for outstanding loans, and excess cash can be reinvested at a quarterly rate of 2.5%.  Which source of financing gives the lower expected cost?  Which financing option would you recommend?

Long-Term Financing Decisions

Falcon Air Conditioner (FAC) has $1 million in EBIT for year ended 2011 with the following balance sheet:

Balance Sheet As of December 31, 2011
Assets                                                                          Liabilities & Capital
Current assets              $2,000,000                  Debt(@ 8%)                            $1,250,000
Net fixed assets                         4,750,000                  Common stock; $10 par                        2,500,000
Preferred stock (@ 10%)           2,000,000
Retained earnings                      1,000,000
Total Assets                 $6,750,000                  Total Liabilities & Capital        $6,750,000
========                                                                    ========
FAC expects that the existing debt and preferred stock will not be retired until the year 2014; hence they will remain in the same amount next year.  FAC is expected to maintain its dividend payout ratio on common stock at the level of 10% next year.  FAC’s corporate tax rate is 40%.

FAC plans to undertake an expansion project, which is expected to increase EBIT to $1.2 million in 2012 (an increase of $200,000 from the year 2008 EBIT).  It needs $500,000 of external capital to finance the expansion, and it is considering the following three possibilities:

1.   New bank term loan, with an interest rate of 10%; its sinking fund provision requires the loan to be fully amortized over the next 5 years, commencing in 2013.
2.   New preferred stock, with a dividend rate of 12%.
3.   50,000 shares of new common stock to net the firm $10 per share.

Given the information above, compute the EPS under each alternative for the year 2012 using the following table (you don’t have to fill up all cells).






EBIT $1,200,000 $1,200,000 $1,200,000

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