Case $15$

Case $37$

Space$-$Age Materials, Inc.

Financial Analysis and Forecasting

Directed

Most people think of pottery and figurines when they think of ceramics. However, ceramic material is particularly well suited for use under high temperatures and intense pressure, especially if light weight is desirable. Because of these properties, ceramics are ideal for use in high$-$performance engines used in turbocharged automobiles, jet aircraft, and heavy trucks. Unfortunately, though, ceramics are also very brittle, and this characteristic has long prevented their widespread use in such engines.

In $1986,$ however, Daniel Alexander, a materials engineer, and Roger Avalon, a chemical engineer, succeeded in combining silicon carbide fibers with ceramic materials in a manner that preserved the desirable properties of ceramics but eliminated most of the brittleness. They then formed Space$-$Age Materials, Inc., and used their own limited capital to build $50$ prototype turbine blades with the new ceramic material. On the basis of extensive testing by a number of large aerospace companies, the new firm began receiving production$-$quantity orders for the new blades.

The new business was an immediate success. Production began in the summer of $1987.$ Operating losses were incurred during the first short year, but the company has earned a profit in each subsequent year. During $1991$ and $1992$ the number of new orders exceeded Alexander and Avalon's projections. By the end of $1992,$ it was obvious to all$-$including Alexander and Avalon$-$that additional expansion would be required if the firm was to attain its full growth potential or even to keep competitors from eroding its position.

Ironically, Alexander and Avalon's technological successes were making their financial forecasts incorrect. Consequently, they hired Sue Li$,$ an MBA, as the company's financial manager to develop a detailed financial plan. Li knew that the company had been lucky and that some large chemical companies, including Monsanto and DuPont, were thinking about entering the market. Space$-$Age, however, had not been sitting idle. In $1991,$ the company's research$-$and$-$development people produced some exciting breakthroughs, while at the same time there was an increasing trend toward using ceramics in jet engines. As a result, it became apparent that additional funds were probably needed if the company were to maintain, let alone increase, its market share. Therefore, a good financial plan accurately forecasting the future needs of the company is critical to the future success, and probably to the continued existence, of the company.

Li organized Space$-$Age's financial planning process into five steps:

$(1)$ A study is made of basic trends in the materials industry and also in the aerospace and other markets where Space$-$Age expects to operate. How will our customers' needs change over the next five years, and what can we do to meet any existing or developing needs?

Case $15$: Space$-$Age Materials, Inc.: Directed

A set of pro forma financial statements is developed and used to analyze the effects of alter. native operating plans on projected profits and financial ratios. The plan encomper for the coming year and much les years, with the projections being relatively de entire plan is updated every year in November. detailed for the following four requiremeds need to support the company's base$-$case operating

$(3)$ The specific financial requ information is obtained from the pro forma statements. plan are determined. This capital that will be used to meet the financial requirements are identified

$(4)$ The specific sources of financial statements are then modified to include the addition of the

$(5)$ The initially proj finance the projected assets. This involves adjusting the pro forma income capital needed to inde the interest charges associated with any additional debt and an adjust. statement to incls paid if new stock must be issued. These modifications change the initially ment to dividained earnings, and thus change the "external funds needed" to finance the projected retain. These feedback effects require the use of an iterative process to produce a asset expant final set of financial statements. In the past, all this has been done manually consistent a sood bit of time$-$but Li has been working to develop a computerized model to speed up the process.

Space$-$Age's $1988$ through $1992$ historical financial statements, along with three key ratios and industry averages, are given in Tables $1$ and $2.$ The company was operating its fixed assets at ful$]$ capacity in $1992,$ so its $$88\mathrm{.}73$ million of sales represented full$-$capacity sales. Since the firm's marketing department is forecasting a $20$ percent increase in sales for $1993,$ new assets will have to be added. For planning purposes, $Li$ assumes $(1)$ that accounts payable and accruals will spontaneously increase in accordance with standard industry practices, $(2)$ that new long$-$term cap