Betty Simmons, the new financial manager of Okanagan Chemicals Ltd. (OCL), a B.C. producer of specialized chemicals for use in fruit orchards, must prepare a financial forecast for 2013. OCL's 2012 sales were $2 billion, and the marketing department is forecasting a 25% increase for 2013. Simmons thinks the company was operating at full capacity in 2012, but she is not sure about this. The 2012 financial statements, plus some other data, are shown below.
Assume that you were recently hired as Simmons' 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.
Financial Statements and Other Data on OCL
(Millions of Dollars)

C. Key Ratios OCL Industry

a. Describe three ways that pro forma statements are used in financial planning.
b. Explain the steps in financial forecasting.
c. Assume (1) that OCL was operating at full capacity in 2012 with respect to all assets, (2) that all assets must grow proportionally with sales, (3) that accounts payable and accruals will also grow in proportion to sales, and (4) that the 2012 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.
d. How would changes in these items affect the AFN? (1) sales increase, (2) the dividend payout ratio increases, (3) the profit margin increases, (4) the capital intensity ratio increases, and (5) OCL begins paying its suppliers sooner. (Consider each item separately and hold all other things constant.)
e. Briefly explain how to forecast financial statements using the forecast financial statements approach. Be sure to explain how to forecast interest expenses.
f. Now estimate the 2013 financial requirements using the forecast financial statements approach. Assume (1) that each type of asset, as well as payables, accruals, and fixed and variable costs, will be the same percent of sales in 2013 as in 2012; (2) that the payout ratio is held constant at 40%; (3) that external funds needed are financed 50% by notes payable and 50% by long-term debt (no new common stock will be issued); (4) that all debt carries an interest rate of 10 percent; and (5) that interest expenses should be based on the balance of debt at the beginning of the year.
g. Why does the forecasted financial statement approach produce a somewhat different AFN than the equation approach? Which method provides the more accurate forecast?
h. Calculate OCL's forecasted ratios, and compare them with the company's 2012 ratios and with the industry averages. Calculate OCL's forecasted free cash flow and return on invested capital (ROIC).
i. Based on comparisons between OCL's days sales outstanding (DSO) and inventory turnover ratios with the industry average figures, does it appear that OCL is operating efficiently with respect to its inventory and accounts receivable? Suppose OCL was able to bring these ratios into line with the industry averages and reduce its SGA/sales ratio to 33%. What effect would this have on its AFN and its financial ratios? What effect would this have on free cash flow and ROIC?
j. Suppose you now learn that OCL's 2012 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% of capacity.
1. What level of sales could have existed in 2012 with the available fixed assets?
2. How would the existence of excess capacity in fixed assets affect the additional funds needed during 2013?
k. The relationship between sales and the various types of assets is important in financial forecasting. The forecasted financial statements approach, under the assumption that each asset item grows at the same rate as sales, leads to an AFN forecast that is reasonably close to the forecast using the AFN equation. Explain how each of the following factors would affect the accuracy of financial forecasts based on the AFN equation: (1) economies of scale in the use of assets, and (2) lumpy assets.

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A. 2012 Balance Sheer% of %of Sales Cash and securities Sales S 20 1% Accounts payable And accruals $100 5% Accounts receivable Inventories Total current assets Net fixed assets 240 12 Notes payable 24012 Total current liabilities 500 500 25 Common stock 100 200 100 500 200 Long-tem debt Retained earnings Total liabilities and equity Total assets $1000 B. 2012 Incone Statement% of Sales Sales Cost of goods sold (COGS) Sales, general, and administrative costs (SGA) Earmings before interest and taxes Interest Eamings before taxes Taxes (40%) Net income Dividends (40%) Addition to retained eamings $2,000.00 1,200.00 700.00 100.00 10.00 90.00 36.00 54.00 21.60 40 60% 35 Profit Margin Retum On Equity Days Sales Outstanding (365 Days) Inventory Tumover Fixed Assets Tumover Debt/Assets Times Interest Earmed Current Ratio Retum On Invested Capital 2.7% 7.71% 44Days 8.33x 4.0x 4.0% 15.6% 32 Days 11.0x 30% 36% 10.0x 9.4x 2.5x NOPAT/Operating Capital) 6.67% 14%