EXHIBIT C6.1 Recent Financial Results Sales Price-Earnings ($ millions) Ratio (times) 2015 2014 2013 $123.2 $111.3 $104.6 $101.0 $ 96.4 11.4 13.5 14.0 14.2 14.0 2012 2011 must be made of what needs to be raised. And it is even possible that a portion of the expected growth can be internally financed. FORECASTING CONSIDERATIONS In order to develop the forecast, the president, Henry Gilmore, called a group meeting of his senior managers. All agree that the sales projections are "quite reasonable" in view of the activity resulting from the trade shows and the global obsession with sports teams and competitions, and may even be a bit low. They also decide to concentrate on the 2016 forecast at their initial meeting. A few months ago, YB began implementing a number of cost-cutting mea- sures that are expected to generate a 32 percent gross margin each year of the forecast. Due to economies of scale, operating expenses are expected to increase less than proportionately with sales, and the manager group agrees to a 20 percent increase in 2016. The relevant tax rate is 40 percent. The purchasing vice president noted that the financial forecast needs to consider the tighter credit terms offered by many of the firm's suppliers. Com- pany records show that two years ago, about 70 percent of YB's purchases were on terms of 2/10, net 30. That is, most suppliers offered a 2 percent discount to customers who paid within 10 days, with full payment expected by day 30. "We always took the discount when it was offered." Company records show that during the past year, about half of the suppli- ers offered the 2/10, net 30, discount. Fewer vendors are likely to offer cash dis- counts in the future, which will impact the firm's gross margin due to slightly higher prices paid for materials. Therefore, he recommends that the gross mar- gin estimate be reduced to 31 percent, which the group accepts. WORKING CAPITAL ISSUES The discussion then turned to working capital management. Inventory control has been a problem for YB at times. Some in the group believe that inventory turnover can be increased to eight times mainly by using suppliers with shorter delivery times. Others are skeptical, believing that it is unrealistic to think that inventory management can be improved unless there is specific evidence to support this conclusion. The group finally concurs that an estimate based on historical inventory patterns is appropriate. Given the new global customer base, it is clear that the firm's historical experience with its accounts receivable will be of little help in predicting future receivables. For the purpose of this forecast, the group decides to assume that they will offer credit terms of net 30 and that 50 percent of customers will pay on time and all other receivables will be received in 50 days. YB expects that this experience will improve in future years. The marketing vice president is tasked with the responsibility of making payment terms clear to the new foreign buyers, and to working with YB's banks to establish letter of credit facilities. (A letter of credit is a document issued by a bank ensuring payment to a seller of goods, provided certain documents have been presented to the bank. These are documents that prove that the seller has performed the duties under an underlying sales contract and the goods have been supplied as agreed.) The group expects that nearly all sales will be collected, and it estimates that bad debt expense will be "insignificant" and can be ignored. The group also thinks that cash should be 4 percent of sales. The firm's predicted 2016 spending on fixed assets is $35 million. These expenditures partly reflect the replacement of existing equipment but mainly result from the new facilities necessary to accommodate the growth in sales. The note payable will require a 20 percent payoff in 2016. Other current liabilities will increase at the same rate as sales. Existing bond debt and bank loans will require an average payoff of 15 percent of the principal amount. FINANCIAL ISSUES YB will pay $1 million in dividends during 2016, the same amount as in 2015. Although this might appear stingy, the group believes that most profits should be reinvested in the aggressive plans for global growth. Ignore any interest expense for the purpose of calculating the 2016 financial statements. The group realizes that it is likely that most of any new required funds will be borrowed. The finance vice president says he has enough information to develop an estimate for 2016. QUESTIONS 1. Using Exhibits C6.1 and C6.2, develop a pro forma income statement for 2016. Assume that depreciation equals the 2015 amount plus one-sixth of 2016 capital spending. The relevant tax rate is 40 percent. 2. (a) What will be YB's 2016 average collection period? (b) Predict the 2016 level of receivables. Assume that there are no cash sales. 3. Using the 2015 results, calculate the inventory for 2016. 4. Calculate accounts payable, assuming that the amount will increase at the same rate as sales. 5. Develop the 2016 pro forma balance sheet. 6. How much funding will be required in 2016? How much must be raised from external sources? Refer to Exhibit C6.3 for data on the industry. 7. When offered terms of 2/10, net 30, YB has always taken the discount. Does this make financial sense? EXHIBIT C6.2 Financial Statements ($ millions) Income Statement 2015 Other Financial Data 2015 Sales $123.2 Beta Cost of goods sold 91.2 Risk-free return Gross margin 32.0 Market return required Operating expenses 14.0 Dividend yield Earnings before 18.0 Growth in stock price over taxes previous 3 years Taxes (40%) 7.2 Earnings per share Net income $ 10.8 Dividends per share 1.20 1.0% 8.0% 1.0% 8.0% $10.80 $ 1.00 Assets Balance Sheet 2015 Liabilities 2.6 Accounts payable $ $ 7.1 2.4 Cash and short-term investments Accounts receivable Inventory Current assets Gross fixed assets Net fixed assets Total assets 13.0 13.0 $ 28.6 $ 55.0 39.8 $ 68.4 Notes payable Other current liabilities Current liabilities Bonds and bank debt Owners' equity Total liabilities and owners' equity 3.7 $ 13.2 21.0 $ 34.2 $ 68.4 * After accumulated depreciation. * After accumulated depreciation. EXHIBIT C6.3 Selected Industry Ratios and Other Financial Data Current ratio 3.1 times Quick ratio 1.5 times Debt ratio 46.8% Times interest earned 10.6 times 250 Young Brands Major competitors with sales greater than $1 billion: Cintas Sales: $3.8 billion Beta: 0.92 Price-earnings ratio: 15.8 times Dividend yield: 1.8% Debt/asset ratio: 47% PVH Corp. Sales: $4.6 billion Beta: 1.91 Price-earnings ratio: 11.6 times Dividend yield: 0.3% Debt/asset ratio: 64% Competitor with sales below $1 billion (beta about 1.50) Fossil Inc. (debt/asset ratio: 28%) EXHIBIT C6.1 Recent Financial Results Sales Price-Earnings ($ millions) Ratio (times) 2015 2014 2013 $123.2 $111.3 $104.6 $101.0 $ 96.4 11.4 13.5 14.0 14.2 14.0 2012 2011 must be made of what needs to be raised. And it is even possible that a portion of the expected growth can be internally financed. FORECASTING CONSIDERATIONS In order to develop the forecast, the president, Henry Gilmore, called a group meeting of his senior managers. All agree that the sales projections are "quite reasonable" in view of the activity resulting from the trade shows and the global obsession with sports teams and competitions, and may even be a bit low. They also decide to concentrate on the 2016 forecast at their initial meeting. A few months ago, YB began implementing a number of cost-cutting mea- sures that are expected to generate a 32 percent gross margin each year of the forecast. Due to economies of scale, operating expenses are expected to increase less than proportionately with sales, and the manager group agrees to a 20 percent increase in 2016. The relevant tax rate is 40 percent. The purchasing vice president noted that the financial forecast needs to consider the tighter credit terms offered by many of the firm's suppliers. Com- pany records show that two years ago, about 70 percent of YB's purchases were on terms of 2/10, net 30. That is, most suppliers offered a 2 percent discount to customers who paid within 10 days, with full payment expected by day 30. "We always took the discount when it was offered." Company records show that during the past year, about half of the suppli- ers offered the 2/10, net 30, discount. Fewer vendors are likely to offer cash dis- counts in the future, which will impact the firm's gross margin due to slightly higher prices paid for materials. Therefore, he recommends that the gross mar- gin estimate be reduced to 31 percent, which the group accepts. WORKING CAPITAL ISSUES The discussion then turned to working capital management. Inventory control has been a problem for YB at times. Some in the group believe that inventory turnover can be increased to eight times mainly by using suppliers with shorter delivery times. Others are skeptical, believing that it is unrealistic to think that inventory management can be improved unless there is specific evidence to support this conclusion. The group finally concurs that an estimate based on historical inventory patterns is appropriate. Given the new global customer base, it is clear that the firm's historical experience with its accounts receivable will be of little help in predicting future receivables. For the purpose of this forecast, the group decides to assume that they will offer credit terms of net 30 and that 50 percent of customers will pay on time and all other receivables will be received in 50 days. YB expects that this experience will improve in future years. The marketing vice president is tasked with the responsibility of making payment terms clear to the new foreign buyers, and to working with YB's banks to establish letter of credit facilities. (A letter of credit is a document issued by a bank ensuring payment to a seller of goods, provided certain documents have been presented to the bank. These are documents that prove that the seller has performed the duties under an underlying sales contract and the goods have been supplied as agreed.) The group expects that nearly all sales will be collected, and it estimates that bad debt expense will be "insignificant" and can be ignored. The group also thinks that cash should be 4 percent of sales. The firm's predicted 2016 spending on fixed assets is $35 million. These expenditures partly reflect the replacement of existing equipment but mainly result from the new facilities necessary to accommodate the growth in sales. The note payable will require a 20 percent payoff in 2016. Other current liabilities will increase at the same rate as sales. Existing bond debt and bank loans will require an average payoff of 15 percent of the principal amount. FINANCIAL ISSUES YB will pay $1 million in dividends during 2016, the same amount as in 2015. Although this might appear stingy, the group believes that most profits should be reinvested in the aggressive plans for global growth. Ignore any interest expense for the purpose of calculating the 2016 financial statements. The group realizes that it is likely that most of any new required funds will be borrowed. The finance vice president says he has enough information to develop an estimate for 2016. QUESTIONS 1. Using Exhibits C6.1 and C6.2, develop a pro forma income statement for 2016. Assume that depreciation equals the 2015 amount plus one-sixth of 2016 capital spending. The relevant tax rate is 40 percent. 2. (a) What will be YB's 2016 average collection period? (b) Predict the 2016 level of receivables. Assume that there are no cash sales. 3. Using the 2015 results, calculate the inventory for 2016. 4. Calculate accounts payable, assuming that the amount will increase at the same rate as sales. 5. Develop the 2016 pro forma balance sheet. 6. How much funding will be required in 2016? How much must be raised from external sources? Refer to Exhibit C6.3 for data on the industry. 7. When offered terms of 2/10, net 30, YB has always taken the discount. Does this make financial sense? EXHIBIT C6.2 Financial Statements ($ millions) Income Statement 2015 Other Financial Data 2015 Sales $123.2 Beta Cost of goods sold 91.2 Risk-free return Gross margin 32.0 Market return required Operating expenses 14.0 Dividend yield Earnings before 18.0 Growth in stock price over taxes previous 3 years Taxes (40%) 7.2 Earnings per share Net income $ 10.8 Dividends per share 1.20 1.0% 8.0% 1.0% 8.0% $10.80 $ 1.00 Assets Balance Sheet 2015 Liabilities 2.6 Accounts payable $ $ 7.1 2.4 Cash and short-term investments Accounts receivable Inventory Current assets Gross fixed assets Net fixed assets Total assets 13.0 13.0 $ 28.6 $ 55.0 39.8 $ 68.4 Notes payable Other current liabilities Current liabilities Bonds and bank debt Owners' equity Total liabilities and owners' equity 3.7 $ 13.2 21.0 $ 34.2 $ 68.4 * After accumulated depreciation. * After accumulated depreciation. EXHIBIT C6.3 Selected Industry Ratios and Other Financial Data Current ratio 3.1 times Quick ratio 1.5 times Debt ratio 46.8% Times interest earned 10.6 times 250 Young Brands Major competitors with sales greater than $1 billion: Cintas Sales: $3.8 billion Beta: 0.92 Price-earnings ratio: 15.8 times Dividend yield: 1.8% Debt/asset ratio: 47% PVH Corp. Sales: $4.6 billion Beta: 1.91 Price-earnings ratio: 11.6 times Dividend yield: 0.3% Debt/asset ratio: 64% Competitor with sales below $1 billion (beta about 1.50) Fossil Inc. (debt/asset ratio: 28%)