Reference no: EM132612948

New World Chemicals Inc.

Financial Forecasting

Sue Wilson, the new financial manager of new world chemicals (NWC), a California producer of specialized chemicals for use in fruit orchards, you must prepare financial forecast for 2003. NWC's 2002 sales were $2 billion, and the marketing department is forecasting a 25 percent increase for 2003. Wilson thinks the company was operating at full capacity in 2002, but she is not sure about this. The 2002 financial statements, plus some other data..

Financial Statements and Other Data on NWC

(Millions of Dollars)

A. 2002 BALANCE SHEET

Cash & Securities $ 20

Accounts Payable & Accrued Liabilities $ 100

Accounts Receivable 240

Notes Payable 100

Inventories 240

Total Current Liabilities $ 200

Total Current Assets $ 500

Long-Term Debt 100

Common Stock 500

Net Fixed Assets 500

Retained Earnings 200

Total Assets $1,000

Total Liabilities and Equity $1,000

B. 2002 INCOME STATEMENT

Sales $2,000.00

Less: Variable Costs 1,200.00

Fixed Costs 700.00

Earnings before Interest and Taxes (EBIT) $ 100.00

Interest 16.00

Earnings before Taxes (EBT) $ 84.00

Taxes (40%) 33.60

Net Income $ 50.40

Dividends (30%) $ 15.12

Addition to Retained Earnings $ 35.28

C. KEY RATIOS

NWC INDUSTRY COMMENT

Basic Earning Power 10.00% 20.00%

Profit Margin 2.52 4.00

Return on Equity 7.20 15.60

Days Sales Outstanding (365 Days) 43.80 Days 32.00 Days

Inventory Turnover 8.33? 11.00?

Fixed Assets Turnover 4.00 5.00

Total Assets Turnover 2.00 2.50

Debt/Assets 30.00% 36.00%

Times Interest Earned 6.25? 9.40?

Current Ratio 2.50 3.00

Payout Ratio 30.00% 30.00%

Assume that you were recently hired as Wilson's assistant, and your first major task is to help her develop the forecast. She asked you to begin by answering the following set of questions.

Question A. Assume (1) that NWC was operating at full capacity in 2002 with respect to all assets, (2) that all assets must grow proportionally with sales, (3) that accounts payable and accrued liabilities will also grow in proportion to sales, and (4) that the 2002 profit margin and dividend payout will be maintained. Under these conditions, what will the company's financial requirements be for the coming year? Use the AFN equation to answer this question.

Question B. Now estimate the 2003 financial requirements using the projected financial statement approach. Disregard the assumptions in part a, and now assume (1) that each type of asset, as well as payables, accrued liabilities, and fixed and variable costs, grow in proportion to sales; (2) that NWC was operating at full capacity; (3) that the payout ratio is held constant at 30 percent; and (4) that external funds needed are financed 50 percent by notes payable and 50 percent by long-term debt (no new common stock will be issued.)

Question C. Why do the two methods produce somewhat different AFN forecasts? Which method provides the more accurate forecast?

Question D. Calculate NWC's forecasted ratios, and compare them with the company's 2002 ratios and with the industry averages. How does NWC compare with the average firm in its industry, and is the company expected to improve during the coming year?

Question E. Calculate NWC's free cash flow for 2003.

Question F. Suppose you now learn that NWC's 2002 receivables and inventories were in line with required levels, given the firm's credit and inventory policies, but that excess capacity existed with regard to fixed assets. Specifically, fixed assets were operated at only 75 percent of capacity. (1) What level of sales could have existed in 2002 with the available fixed assets? What would the fixed assets-to-sales ratio have been if NWC had been operating at full capacity? (2) How would the existence of excess capacity in fixed assets affect the additional funds needed during 2003?

Question G. Without actually working out the numbers, how would you expect the ratios to change in the situation where excess capacity in fixed assets exists? Explain your reasoning.

Question H. On the basis of comparisons between NWC's days' sales outstanding (DSO) and inventory turnover ratios with the industry average figures, does it appear that NWC is operating efficiently with respect to its inventories and accounts receivable? If the company were able to bring these ratios into line with the industry averages, what effect would this have on its AFN and its financial ratios?

Question I. How would changes in these items affect the AFN? (1) the dividend payout ratio, (2) the profit margin, (3) the capital intensity ratio, and (4) if NWC begins buying from its suppliers on terms that permit it to pay after 60 days rather than after 30 days. (Consider each item separately and hold all other things constant.)