0.5 CASE #3 - HORIZON INVESTMENTS (15 marks in total) The following information refers to Questions 7.1-7.5 Selene Pinna, an investment manager at Horizon Investments, intends to hire a new investment analyst. After conducting initial interviews, Pinna has narrowed the pool to three candidates. She plans to conduct second interviews to further assess the candidates' knowledge of industry and company analysis. Prior to the second interviews, Pinna asks the candidates to analyze Super Nova Web Systems, a company that manufactures internet networking products. Each candidate is provided Super Nova's financial information presented in Exhibit L. Exhibit 1. Super Nova Web Systems Selected Financial Information (in millions of $) Year Ended: 2010 2011 2012 Net sales 46.8 50.5 53.9 Cost of sales 18.2 18.4 18.8 Gross profit 28.6 32.1 35.1 Selling, general, and administrative (SG&A) expenses 19.3 22.5 25.1 Operating income 9.3 9.6 10.0 Interest expense 0.7 0.6 Income before provision for income tax 8.8 8.9 9.4 Provision for income taxes 2.8 2.8 3.1 Net income 6.0 6.1 6.3 Pinna request each candidate to predict the 2013 income statement for Super Nova, and candidates are asked to highlight the essential assumptions in their analyses. Besides, candidates are asked to include the economic outlook of Horizon Investments in their predictions, which estimates 3.6% for nominal GDP growth, with inflation and real GDP growth of 1.6% and 2.0%, respectively. Once Pinna receives the forecast models from all candidates, she schedules second round interviews. She prepared the summary of key assumptions in all three models beforehand in Exhibit 2. Exhibit 2. Summary of Key Assumptions Used in Candidates' Models Metric Candidate A Candidate B Candidate C Net sales Net sales will grow at Industry sales will grow at the Net sales will grow 50 the average annual same rate as nominal GDP basis points slower growth rate in net sales but Super Nova will have a 2 than nominal GDP. over the 2010-2012 time percentage points decline in period. market share. Cost of sales 2013 gross margin is 2013 gross margin will 2013 gross margin is expected to be the same decline as costs increase by expected to be 20 basis as 2010-2012 average. expected inflation. points more than 2012. Selling, general, and 2013 SG&Aet sales 2013 SG&A will grow at the 2013 SG&Aet sales administrative ratio is expected to be rate of inflation. ratio will not change (SG&A) expenses the same as 2010-2012 from 2012 one. average. Interest expense 2013 interest expenses 2013 interest expense is 2013 interest expense will be the same expected to be the same as in is expected to be the assuming the effective 2012. as 2010-2012 average. same Income taxes rate does not change from 2012 2013 effective tax rate 2013 effective tax rate will 2013 effective tax rate will be the same as the equal the blended statutory is expected to be the 2012 rate. rate of 30%. same as 2010-2012 effective tax rate average. Question 7.1 (3 marks) Based on Exhibit I, which of the following provides the strongest evidence that Super Nova displays economies of scale? A. Increasing net sales B. Profit margins that are increasing with net sales C. Gross profit margins that are increasing with net sales Question 7.2 (3 marks) Based on Exhibit 2, the job candidate most likely using a bottom-up approach to model net sales is: A. Candidate A. B. Candidate B. C. Candidate C. Question 7.3 (3 marks) Based on Exhibit 2. the modeling approach used by Candidate B to project future net sales is most accurately classified as a: A. hybrid approach. B. top-down approach. C. bottom-up approach. Question 7.4 (3 marks) Based on Exhibits 1 and 2, Candidate C's forecast for cost of sales in 2013 is closest to: A. $18.3 million. B. $18.9 million. C. $19.3 million. Question 7.5 (3 marks) Based on Exhibits 1 and 2, Candidate A's forecast for selling general, and administrative expenses in 2013 is closest to: A. $23.8 million. B. $25.5 million. C. $27.4 million