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Chapter 10--Forecasting Financial Statements

Student: ___________________________________________________________________________

1. The objective of forecasting is to develop

A. stand alone financial statements for future analysis.
B. a set of realistic expectations for future value-relevant payoffs.
C. a balance sheet and income statement that articulate.
D. financial statements for comparison to industry averages.

2. Nichols and Wahlen's 2004 study showed that superior forecasting provides the potential to earn superior
security returns. Nichols and Wahlen's findings indicate
A. that an investor could earn excess returns if the investor could predict accurately the sign of the change in
earnings one year ahead.
B. that an investor could earn excess returns if the investor could predict accurately the magnitude of the change
in earnings one year ahead.
C. that an investor could earn excess returns if the investor could predict accurately the sign of the change in
cash flows from operations one year ahead.
D. that an investor could earn excess returns if the investor could predict accurately the sign of the change in
working capital one year ahead.

3. Financial statement forecasts rely on additivity within financial statements and articulation across financial
statements. Given this information forecasts of future growth in inventory will most likely affect growth in
A. accounts receivables.
B. accounts payable.
C. depreciation.
D. salary payable.

4. Financial statement forecasts rely on additivity within financial statements and articulation across financial
statements. Given this information sales growth forecasts will most likely affect growth in
A. accounts receivables.
B. accounts payable.
C. depreciation.
D. salary payable.
5. Projecting sales price changes depends on factors specific to the firm and its industry that might affect
demand and price elasticity. Which of the following types of companies would most likely be able to increase
prices?
A. A firm in a capital intensive industry that is expected to operate near capacity for the near future.
B. A firm in a capital intensive industry in which excess capacity exists.
C. A firm operating in an industry that is expected to experience technological improvements in its production
process.
D. A firm operating in an industry that is transitioning from the high growth to the maturity phase of its life
cycle.

6. Projecting sales price changes depends on factors specific to the firm and its industry that might affect
demand and price elasticity. Which of the following companies would most likely not be able to increase prices
in the near future?
A. A firm in a capital intensive industry that is expected to operate near capacity for the near future.
B. A firm in a capital intensive industry in which excess capacity exists.
C. A firm operating in an industry that is expected to maintain its current production processes.
D. A firm operating in an industry that is transitioning from the introduction phase to the high growth phase of
its life cycle.

7. If a company has very low operating leverage (i.e. a low proportion of fixed costs the cost structure) and no
changes are expected in operations
A. percentage change income statement percentages can serve as the basis for projecting operating expenses.
B. using common-size income statement percentages will overstate future projected operating expenses.
C. using common-size income statement percentages will understate future projected operating expenses.
D. using common-size income statement percentages can serve as a reasonable basis for projecting future
operating expenses.

8. When projecting operating expenses it is important to determine the mix of fixed and variable costs, one clue
suggesting the presence of fixed costs is
A. the percentage change in cost of goods sold in prior years is significantly greater than the percentage change
in sales.
B. the percentage change in cost of goods sold in prior years is significantly less than the percentage change in
sales.
C. low capital intensity in the production process.
D. the percentage change in sales in prior years is significantly greater than the percentage change in
receivables.
9. To ensure that the financial statements articulate it is important that the change in the cash balance on the
balance sheet each year agrees with
A. the cash collections from sales in the projected income statement.
B. the cash provided by or used by operations on the projected statement of cash flows.
C. the net change in cash on the projected statement of cash flows.
D. the net change in working capital from period to period.

10. An analyst using the inventory turnover ratio to calculate future levels of inventory may face the problem
that
A. the method reduces the potential understatement inherent in average balances.
B. the method can introduce artificial volatility in ending balances.
C. the method results in understating inventory each year.
D. the method results in overstating inventory each year.

11. Just Camshafts sells auto parts. Provided below is selected financial information from the company’s 2007
annual report:

Just Camshafts
Selected Financial Statement data
Fiscal year end 2007 2006
(amounts in thousands of dollars)
Net sales $125,410 $106,380
Cost of Goods Sold -104,090 -89,359
Gross Profit $21,320 $17,021

Inventory $31,353 $30,850

Using Just Camshafts financial information what is the company’s inventory turnover ratio for 2007?
A. 0.69
B. 1.00
C. 3.35
D. 4.03

12. Just Camshafts sells auto parts. Provided below is selected financial information from the company’s 2007
annual report:

Just Camshafts
Selected Financial Statement data
Fiscal year end 2007 2006
(amounts in thousands of dollars)
Net sales $125,410 $106,380
Cost of Goods Sold -104,090 -89,359
Gross Profit $21,320 $17,021

Inventory $31,353 $30,850

 Just Camshafts forecasts that sales will grow by 25% in 2008 and that its cost of goods sold to sales ratio will be the same in 2008 as it was in 2007.
If these assumptions prove correct and Just Camshafts inventory turnover ratio for 2008 is 4.5 what will be the level of inventory at the end of 2008?
A. $31,353
B. $38,320
C. $40,000
D. $42,314

13. Baseball Card Land, Inc. sells baseball cards and other memorabilia. The company tries to maintain a cash
balance equivalent to approximately 30 days of sales. Sales in 2006 amounted to $352,412 and the company
expects growth in 2007 of 33% and in 2008 of 40%.

Given the information provided about Baseball Card Land what is the company’s 2007 projected year-end cash
balance?
A. $966
B. $28,965
C. $15,623
D. $38,524

14. Baseball Card Land, Inc. sells baseball cards and other memorabilia. The company tries to maintain a cash
balance equivalent to approximately 30 days of sales. Sales in 2006 amounted to $352,412 and the company
expects growth in 2007 of 33% and in 2008 of 40%.

Given the information provided about Baseball Card Land what is the company’s 2008 projected annual sales?
A. $656,191
B. $493,377
C. $187,483
D. $542,333

15. Baseball Card Land, Inc. sells baseball cards and other memorabilia. The company tries to maintain a cash
balance equivalent to approximately 30 days of sales. Sales in 2006 amounted to $352,412 and the company
expects growth in 2007 of 33% and in 2008 of 40%.

Given the information provided about Baseball Card Land what is the company’s 2008 projected cash
balance?
A. $53,934
B. $49,524
C. $21,873
D. $38,524
16. Financial statement forecasts are important analysis tools because forecasts of
______________________________ play a central role in valuation and many other financial decision
contexts.
________________________________________

17. Realistic expectations are ____________________ and ____________________.

________________________________________

18. Financial statement forecasts should rely on ____________________ within financial statements.
________________________________________

19. Financial statement forecasts should rely on _________________________ across financial statements.
________________________________________

20. A firm in a mature industry with little expected change in its market share might anticipate volume increases
equal to the growth rate in the _________________________ with in its geographic markets.
________________________________________

21. Firms which have differentiated ___________________________________ for its products may have a
greater potential to increase prices.
________________________________________

22. It may be difficult to forecast sales for firms with _________________________ patterns because their
historical growth rates reflect wide variations in both direction and amount from year to year.
________________________________________

23. A company that has a cost structure in which its costs grow at a lesser rate than its sale enjoys
___________________________________.
________________________________________

24. To develop forecasts of individual assets, the analyst must first link historical growth rates for individual
assets to historical growth rates in sales or other ___________________________________.
________________________________________
25. The analyst can capture projected levels of operating activity by using ______________________________
to develop forecasts for individual assets.
________________________________________

26. To develop forecasts of individual assets the analyst must first link historical growth rates for individual
assets to historical growth rates in ____________________ and other activity-based drivers.
________________________________________

27. For some types of assets, such as plant, property and equipment, asset growth typically
____________________ future sales growth.
________________________________________

28. For some types of assets, such as accounts receivable asset growth typically ____________________ future
sales growth.
________________________________________

29. When projecting ____________________, the analyst should consider economy-wide factors such as the
expected rate of general price inflation in the economy.
________________________________________

30. A firm in transition from the high growth to the mature phase of its life cycle, or a firm with significant
technological improvements in its production processes, might expect increases in
______________________________ but decreases in sales prices per unit.
________________________________________

31. If a firm competes in a ___________________________________ industry that the analyst expects will
operate near capacity for the next few years, then price increases will be more likely.
________________________________________
32. Many times an analyst will compute ending accounts receivable or inventory balances using turnover ratios,
discuss the advantage and disadvantage of using this methodology.

33. The authors set forth a six step forecasting game plan for preparing pro forma financial statements. Discuss
the six steps necessary to prepare the three principal financial statements.

34. One problem caused by using turnover ratios to calculate asset balances is that it can lead to volatility in
projected ending balances. What might an analyst do to reduce the "sawtooth" pattern caused by using turnover
ratios?

35. The first step in the forecasting game plan is to project sales and other revenues. Sales numbers are
determined by both a volume component and price component. Projecting prices depends on factors specific to
the firm and its industry that might affect demand and price elasticity. For the following types of firms discuss
whether it would be likely that the firm would be able to raise future prices:

a. A firm in a capital intensive industry that is expected to operate near capacity for the near future.
b. A firm in an industry that is expected to experience numerous technological improvements.
c. A firm with products which are transitioning from the growth to maturity phase of the product life cycle.
d. A firm that has established a well known brand name and image.
36. As an analyst it is important when projecting sales to make estimates about future changes in sales volume.
Compare how you might make estimates about future sales value for a company in a mature industry and one in
a rapidly growing industry.

37. Toys, Inc. manufactures and markets toys. Selected income statement data from 2005 and 2004 appear
below:

Toys, Inc.
Selected Income Statement data
Fiscal year end 12/31/2005 12/31/2004
(amounts in thousands of dollars)
Net sales $4,885,340 $4,637,924
Cost of Goods Sold -3,824,353 -3,638,990
Gross profit 1,060,987 998,934

Required:
a. An analyst can sometimes estimate the variable cost as a percentage of sales for a particular cost by dividing the amount of the
change in the cost item between two years by the amount of the change in sales for those two years. The analyst can then multiply the
variable cost percentage times sales to determine the total variable cost. Subtracting the variable cost yields the fixed cost for that
particular item. Follow this procedure to determine the cost structure for costs of goods sold for Toys, Inc.
b. Toys, Inc. projects sales to grow at the following percentages in future years: 2006, 9 percent; 2007, 11 percent; 2008, 15 percent.
Using this information project sales, cost of goods sold and gross profit for Toys, Inc. for 2006 to 2008.
38. Clothes, Inc. sells women's clothes. Provided below is selected financial statement information:

Clothes, Inc.
Selected Financial Statement data
Fiscal year end 2005 2004
(amounts in thousands of dollars)
Net sales $47,895 $42,589
Cost of Goods Sold (35,952) (32,588)
Gross profit $11,943 $10,001

Inventory $ 5,548 $ 4,948

Required:
a. Compute the inventory turnover ratio for 2005.
b. Clothes, Inc. projects that sales will grow at a compound rate of 7% per year for years 2006-2008 and that the cost of goods sold to sales
percentage will equal that realized in 2005. Compute the projected implied level of inventory at the end of 2006 to 2008.

39. Cash, Inc. sells numerous office supply products through a national distribution center. The company has
focused on maintaining a cash balance equivalent to approximately 14 days of sales. Sales in 2005 amounted to
$125,980,673 and the company expects growth in 2006 of 11% and in 2007 of 15%. Given this information
determine Cash, Inc.'s projected year-end cash balance for 2006 and 2007.
40. You are provided the following information about Davis Corp.s Accounts Receivable and Sales:

Year
2007-Beginnin
g Balance of
A/R = $791M
Year 2007
-Ending
Balance of A/R
= $807M
Year 2007 -
Sales =
$3,002M

Assumptions:
Sales growth
will be equal to
6% per year
A/R turnover
will stay
constant
throughout the
forecast period

Required:
a. Using this information forecast Davis Corp’s the growth in Accounts Receivable for years 2008-2012.
b. What problem does a constant A/R turnover assumption cause?
c. Provide a solution to the problem caused by a constant A/R turnover assumption.

41. The following balance sheet and income statement pertain to Graham Corp., using the following
assumptions complete a forecasted 2008 income statement:

Assumpt
ions for
2008:
Revenue growth rate 32%
COGS 64% of sales
Operating expenses 23% of sales
Interest expense 10% of
beginning
long-term
debt
Tax rate 35%
Graham Corp. Consolidated Statement of Income
(Thousands except per share amounts) 2007

Net Revenues $345,871

Cost of Revenue (226,546)
SG&A (83,009)
Operating Income 36,316
Interest Expense (484)
Income Before Income Taxes 35,832
Income taxes (12,541)
Net Income $23,291

Graham Corp Consolidated Balance Sheet

(Thousands) 2007
Current Assets
Cash and Equivalents 7,905
Merchandise inventory 6,308
Accounts receivable 6,614
PPE (including intangibles), net 39,458
Total Assets 60,285

Liabilities and Stockholders' Equity

Accounts payable 9,643
Long-term debt 13,500
Shareholders' Equity
Common stock and APIC 28,613
Retained earnings 8,529
Total Liabilities and Shareholders' Eq. 60,285
Chapter 10--Forecasting Financial Statements Key

1. The objective of forecasting is to develop

A. stand alone financial statements for future analysis.
B. a set of realistic expectations for future value-relevant payoffs.
C. a balance sheet and income statement that articulate.
D. financial statements for comparison to industry averages.

2. Nichols and Wahlen's 2004 study showed that superior forecasting provides the potential to earn superior
security returns. Nichols and Wahlen's findings indicate
A. that an investor could earn excess returns if the investor could predict accurately the sign of the change in
earnings one year ahead.
B. that an investor could earn excess returns if the investor could predict accurately the magnitude of the change
in earnings one year ahead.
C. that an investor could earn excess returns if the investor could predict accurately the sign of the change in
cash flows from operations one year ahead.
D. that an investor could earn excess returns if the investor could predict accurately the sign of the change in
working capital one year ahead.

3. Financial statement forecasts rely on additivity within financial statements and articulation across financial
statements. Given this information forecasts of future growth in inventory will most likely affect growth in
A. accounts receivables.
B. accounts payable.
C. depreciation.
D. salary payable.

4. Financial statement forecasts rely on additivity within financial statements and articulation across financial
statements. Given this information sales growth forecasts will most likely affect growth in
A. accounts receivables.
B. accounts payable.
C. depreciation.
D. salary payable.
5. Projecting sales price changes depends on factors specific to the firm and its industry that might affect
demand and price elasticity. Which of the following types of companies would most likely be able to increase
prices?
A. A firm in a capital intensive industry that is expected to operate near capacity for the near future.
B. A firm in a capital intensive industry in which excess capacity exists.
C. A firm operating in an industry that is expected to experience technological improvements in its production
process.
D. A firm operating in an industry that is transitioning from the high growth to the maturity phase of its life
cycle.

6. Projecting sales price changes depends on factors specific to the firm and its industry that might affect
demand and price elasticity. Which of the following companies would most likely not be able to increase prices
in the near future?
A. A firm in a capital intensive industry that is expected to operate near capacity for the near future.
B. A firm in a capital intensive industry in which excess capacity exists.
C. A firm operating in an industry that is expected to maintain its current production processes.
D. A firm operating in an industry that is transitioning from the introduction phase to the high growth phase of
its life cycle.

7. If a company has very low operating leverage (i.e. a low proportion of fixed costs the cost structure) and no
changes are expected in operations
A. percentage change income statement percentages can serve as the basis for projecting operating expenses.
B. using common-size income statement percentages will overstate future projected operating expenses.
C. using common-size income statement percentages will understate future projected operating expenses.
D. using common-size income statement percentages can serve as a reasonable basis for projecting future
operating expenses.

8. When projecting operating expenses it is important to determine the mix of fixed and variable costs, one clue
suggesting the presence of fixed costs is
A. the percentage change in cost of goods sold in prior years is significantly greater than the percentage change
in sales.
B. the percentage change in cost of goods sold in prior years is significantly less than the percentage change in
sales.
C. low capital intensity in the production process.
D. the percentage change in sales in prior years is significantly greater than the percentage change in
receivables.
9. To ensure that the financial statements articulate it is important that the change in the cash balance on the
balance sheet each year agrees with
A. the cash collections from sales in the projected income statement.
B. the cash provided by or used by operations on the projected statement of cash flows.
C. the net change in cash on the projected statement of cash flows.
D. the net change in working capital from period to period.

10. An analyst using the inventory turnover ratio to calculate future levels of inventory may face the problem
that
A. the method reduces the potential understatement inherent in average balances.
B. the method can introduce artificial volatility in ending balances.
C. the method results in understating inventory each year.
D. the method results in overstating inventory each year.

11. Just Camshafts sells auto parts. Provided below is selected financial information from the company’s 2007
annual report:

Just Camshafts
Selected Financial Statement data
Fiscal year end 2007 2006
(amounts in thousands of dollars)
Net sales $125,410 $106,380
Cost of Goods Sold -104,090 -89,359
Gross Profit $21,320 $17,021

Inventory $31,353 $30,850

Using Just Camshafts financial information what is the company’s inventory turnover ratio for 2007?
A. 0.69
B. 1.00
C. 3.35
D. 4.03

12. Just Camshafts sells auto parts. Provided below is selected financial information from the company’s 2007
annual report:

Just Camshafts
Selected Financial Statement data
Fiscal year end 2007 2006
(amounts in thousands of dollars)
Net sales $125,410 $106,380
Cost of Goods Sold -104,090 -89,359
Gross Profit $21,320 $17,021

Inventory $31,353 $30,850

 Just Camshafts forecasts that sales will grow by 25% in 2008 and that its cost of goods sold to sales ratio will be the same in 2008 as it was in 2007.
If these assumptions prove correct and Just Camshafts inventory turnover ratio for 2008 is 4.5 what will be the level of inventory at the end of 2008?
A. $31,353
B. $38,320
C. $40,000
D. $42,314

13. Baseball Card Land, Inc. sells baseball cards and other memorabilia. The company tries to maintain a cash
balance equivalent to approximately 30 days of sales. Sales in 2006 amounted to $352,412 and the company
expects growth in 2007 of 33% and in 2008 of 40%.

Given the information provided about Baseball Card Land what is the company’s 2007 projected year-end cash
balance?
A. $966
B. $28,965
C. $15,623
D. $38,524

14. Baseball Card Land, Inc. sells baseball cards and other memorabilia. The company tries to maintain a cash
balance equivalent to approximately 30 days of sales. Sales in 2006 amounted to $352,412 and the company
expects growth in 2007 of 33% and in 2008 of 40%.

Given the information provided about Baseball Card Land what is the company’s 2008 projected annual sales?
A. $656,191
B. $493,377
C. $187,483
D. $542,333

15. Baseball Card Land, Inc. sells baseball cards and other memorabilia. The company tries to maintain a cash
balance equivalent to approximately 30 days of sales. Sales in 2006 amounted to $352,412 and the company
expects growth in 2007 of 33% and in 2008 of 40%.

Given the information provided about Baseball Card Land what is the company’s 2008 projected cash
balance?
A. $53,934
B. $49,524
C. $21,873
D. $38,524
16. Financial statement forecasts are important analysis tools because forecasts of
______________________________ play a central role in valuation and many other financial decision
contexts.
future payoffs

17. Realistic expectations are ____________________ and ____________________.

unbiased, objective

18. Financial statement forecasts should rely on ____________________ within financial statements.
additivity

19. Financial statement forecasts should rely on _________________________ across financial statements.
articulation

20. A firm in a mature industry with little expected change in its market share might anticipate volume increases
equal to the growth rate in the _________________________ with in its geographic markets.
population

21. Firms which have differentiated ___________________________________ for its products may have a
greater potential to increase prices.
unique characteristics

22. It may be difficult to forecast sales for firms with _________________________ patterns because their
historical growth rates reflect wide variations in both direction and amount from year to year.
cyclical sales

23. A company that has a cost structure in which its costs grow at a lesser rate than its sale enjoys
___________________________________.
economies of scale
24. To develop forecasts of individual assets, the analyst must first link historical growth rates for individual
assets to historical growth rates in sales or other ___________________________________.
activity-based drivers or
activity based drivers

25. The analyst can capture projected levels of operating activity by using ______________________________
to develop forecasts for individual assets.
turnover rates

26. To develop forecasts of individual assets the analyst must first link historical growth rates for individual
assets to historical growth rates in ____________________ and other activity-based drivers.
sales

27. For some types of assets, such as plant, property and equipment, asset growth typically
____________________ future sales growth.
leads

28. For some types of assets, such as accounts receivable asset growth typically ____________________ future
sales growth.
lag

29. When projecting ____________________, the analyst should consider economy-wide factors such as the
expected rate of general price inflation in the economy.
prices

30. A firm in transition from the high growth to the mature phase of its life cycle, or a firm with significant
technological improvements in its production processes, might expect increases in
______________________________ but decreases in sales prices per unit.
sales volume

31. If a firm competes in a ___________________________________ industry that the analyst expects will
operate near capacity for the next few years, then price increases will be more likely.
capital-intensive or
capital intensive
32. Many times an analyst will compute ending accounts receivable or inventory balances using turnover ratios,
discuss the advantage and disadvantage of using this methodology.

One advantage of using this method is that it reduces the potential understatement inherent in average balances.

One disadvantage is that it may introduce artificial volatility in ending balances.

33. The authors set forth a six step forecasting game plan for preparing pro forma financial statements. Discuss
the six steps necessary to prepare the three principal financial statements.

The six steps are:

1. Project revenues from sales and other activities.

2. Project operating expenses and derive projected operating income.
3. Project the assets necessary to support the level of operations projected in the previous steps.
4. Project the operating liabilities and the financial leverage and capital structure necessary to finance the assets projected in step 3.
5. Determine the cost of financing the financial liabilities in the firm’s projected capital structure.
6. Derive the statement of cash flows from the projected income statements and the changes in the projected balance sheet amounts.

34. One problem caused by using turnover ratios to calculate asset balances is that it can lead to volatility in
projected ending balances. What might an analyst do to reduce the "sawtooth" pattern caused by using turnover
ratios?

One thing an analyst might do is estimating the average rate of growth in the asset balance expected over a long
forecast period and then smooth each year-end balance using the average growth rate.

35. The first step in the forecasting game plan is to project sales and other revenues. Sales numbers are
determined by both a volume component and price component. Projecting prices depends on factors specific to
the firm and its industry that might affect demand and price elasticity. For the following types of firms discuss
whether it would be likely that the firm would be able to raise future prices:

a. A firm in a capital intensive industry that is expected to operate near capacity for the near future.
b. A firm in an industry that is expected to experience numerous technological improvements.
c. A firm with products which are transitioning from the growth to maturity phase of the product life cycle.
d. A firm that has established a well known brand name and image.

Suggested answers:

a. In this case, due to capacity constraints the firm should be able to raise prices. Because the industry is capital intensive it is not likely
that a competitor could easily and quickly enter the market and steal market share by cutting prices.
b. This firm would probably not be able to raise prices due to efficiencies brought on by the technological change, although sales
volumes may increase.
c. This firm may find it more difficult to raise prices, as the product's sales reach a level in which demand is more stable. Thus, price
increases may result in consumers switching products, etc.
d. Firms with well known images and brand names may be better positioned to raise prices because consumers feel such brand loyalty.
36. As an analyst it is important when projecting sales to make estimates about future changes in sales volume.
Compare how you might make estimates about future sales value for a company in a mature industry and one in
a rapidly growing industry.

Suggested Solution From SBW:

For a stable firm in a mature industry an analyst may conclude that the firm will not likely increase its market
share, so the analyst might anticipate sales volume increases equal to the growth rate in the population within
the firm’s geographic markets. For a firm that has increased its operating capacity within a particular industry
with high anticipated growth (for example, biotechnology or computer software), the analyst might consider
using the industry growth rate coupled with the potential growth in the firm’s operating capacity when
projecting volume increases.

37. Toys, Inc. manufactures and markets toys. Selected income statement data from 2005 and 2004 appear
below:

Toys, Inc.
Selected Income Statement data
Fiscal year end 12/31/2005 12/31/2004
(amounts in thousands of dollars)
Net sales $4,885,340 $4,637,924
Cost of Goods Sold -3,824,353 -3,638,990
Gross profit 1,060,987 998,934

Required:
a. An analyst can sometimes estimate the variable cost as a percentage of sales for a particular cost by dividing the amount of the
change in the cost item between two years by the amount of the change in sales for those two years. The analyst can then multiply the
variable cost percentage times sales to determine the total variable cost. Subtracting the variable cost yields the fixed cost for that
particular item. Follow this procedure to determine the cost structure for costs of goods sold for Toys, Inc.
b. Toys, Inc. projects sales to grow at the following percentages in future years: 2006, 9 percent; 2007, 11 percent; 2008, 15 percent.
Using this information project sales, cost of goods sold and gross profit for Toys, Inc. for 2006 to 2008.

a.
change in COGS $185,363
change in sales $247,416
Variable cost percentage 75%

Fixed Costs:
2005 $160,348

b.
2006 2007 2008
Projected Growth Rate 9% 11% 15%
Net Sales 5,325,021 5,910,773 6,797,389

Cost of Goods Sold:

Fixed portion ($ 160,348) ($ 160,348) ($ 160,348)
Variable portion (75% of Sales) (3,993,766) (4,433,080) (5,098,042)

Gross Profit 1,170,907 1,317,345 1,538,999

38. Clothes, Inc. sells women's clothes. Provided below is selected financial statement information:

Clothes, Inc.
Selected Financial Statement data
Fiscal year end 2005 2004
(amounts in thousands of dollars)
Net sales $47,895 $42,589
Cost of Goods Sold (35,952) (32,588)
Gross profit $11,943 $10,001

Inventory $ 5,548 $ 4,948

Required:
a. Compute the inventory turnover ratio for 2005.
b. Clothes, Inc. projects that sales will grow at a compound rate of 7% per year for years 2006-2008 and that the cost of goods sold to sales
percentage will equal that realized in 2005. Compute the projected implied level of inventory at the end of 2006 to 2008.

a. Inventory Turnover 6.85

I.T. = $35,952/.5(5,548 + 4,948) = 6.85

b.
Inventory Average Inventory Inventory Percentage
Sales COGS Turnover Inventories beg. Year end year change
2005 47,895.00 $35,952 6.85 5,248 4,948 5,548 12%
2006 51,247.65 $38,469 6.85 5,616 5,548 5,684 2%
2007 54,834.99 $41,161 6.85 6,009 5,684 6,334 11%
2008 58,673.43 $44,043 6.85 6,430 6,334 6,525 3%

39. Cash, Inc. sells numerous office supply products through a national distribution center. The company has
focused on maintaining a cash balance equivalent to approximately 14 days of sales. Sales in 2005 amounted to
$125,980,673 and the company expects growth in 2006 of 11% and in 2007 of 15%. Given this information
determine Cash, Inc.'s projected year-end cash balance for 2006 and 2007.

Annual Average Days Sales Year-end

Sales Sales/Day in Cash Cash Bal.
2005 $125,980,673 Sales/365 Given Sales/Day *14
2006 $139,838,547 383,119 14 $5,363,670
2007 $160,814,329 440,587 14 $6,168,221
40. You are provided the following information about Davis Corp.s Accounts Receivable and Sales:

Year
2007-Beginnin
g Balance of
A/R = $791M
Year 2007
-Ending
Balance of A/R
= $807M
Year 2007 -
Sales =
$3,002M

Assumptions:
Sales growth
will be equal to
6% per year
A/R turnover
will stay
constant
throughout the
forecast period

Required:
a. Using this information forecast Davis Corp’s the growth in Accounts Receivable for years 2008-2012.
b. What problem does a constant A/R turnover assumption cause?
c. Provide a solution to the problem caused by a constant A/R turnover assumption.

a.

2007 2008* 2009* 2010* 2011* 2012*

Sales $3,002 $3,182 $3,373 $3,575 $3,790 $4,017
Beg. A/R balance $791 807 887 909 995 1,023
Ending A/R balance $807 887 909 995 1,023 1,116

Sales Growth Rate 6%

A/R turnover 3.76

Growth in A/R 9.90% 2.48% 9.46% 2.81% 9.09%

b. The constant A/R turnover assumption results in the sawtooth forecasting problem.
c.
2007 2008* 2009* 201 2011* 201
0* 2*
Sales $3,002 $3,182 $3,373 $3,575 $3,790 $4,017
Beg. A/R balance $791 807 887 909 995 1,023
Ending A/R balance $807 887 909 995 1,023 1,116

Sales Growth Rate 6%

A/R turnover 3.76

Yearly Growth in A/R 9.90% 2.45% 9.46% 2.84% 9.08%

Compound Average growth in 6.69%

A/R=
A/R based on CAGR year 1 Y2* Y3* Y4* Y5* Y6*

Beginning Balance $791 807 861 919 980 1,046

Ending Balance $807 861 919 980 1,046 1,116

Growth in A/R 6.69% 6.69% 6.69% 6.69% 6.69%

One potential solution is to: not use the average balance sheet account balance when initially calculating turnover ratios-but rather base it on the
ending balance. Then forecast using average turnover ratios and then smooth changes using the compound average growth rate.

41. The following balance sheet and income statement pertain to Graham Corp., using the following
assumptions complete a forecasted 2008 income statement:

Assumpt
ions for
2008:
Revenue growth rate 32%
COGS 64% of sales
Operating expenses 23% of sales
Interest expense 10% of
beginning
long-term
debt
Tax rate 35%
Graham Corp. Consolidated Statement of Income
(Thousands except per share amounts) 2007

Net Revenues $345,871

Cost of Revenue (226,546)
SG&A (83,009)
Operating Income 36,316
Interest Expense (484)
Income Before Income Taxes 35,832
Income taxes (12,541)
Net Income $23,291

Graham Corp Consolidated Balance Sheet

(Thousands) 2007
Current Assets
Cash and Equivalents 7,905
Merchandise inventory 6,308
Accounts receivable 6,614
PPE (including intangibles), net 39,458
Total Assets 60,285

Liabilities and Stockholders' Equity

Accounts payable 9,643
Long-term debt 13,500
Shareholders' Equity
Common stock and APIC 28,613
Retained earnings 8,529
Total Liabilities and Shareholders' Eq. 60,285

Graham Corp. Consolidated Statements of Income

(Thousands except per share amounts) 2008 2007

Net Revenues $456,550 $345,871

Cost of Goods Sold (292,192) (226,546)
SG&A (105,006) (83,009)
Operating Income 59,352 36,316
Interest Expense (1,350) (484)
Income Before Income Taxes 58,002 35,832
Income taxes (20,301) (12,541)
Net Income $37,701 $23,291
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