Question
FINANCIAL FORECASTING Sue Wilson, the new financial manager of New World Chemicals (NWC), a California producer of specialized chemicals for use in fruit orchards, must
FINANCIAL FORECASTING Sue Wilson, the new financial manager of New World Chemicals (NWC), a California producer of specialized chemicals for use in fruit orchards, must prepare a formal financial forecast for 2022. NWCs 2021 sales were $2 billion, and the marketing department is forecasting a 25% increase for 2022. Wilson thinks the company was operating at full capacity in 2021, but she is not sure. The first step in her forecast was to assume that key ratios would remain unchanged and that it would be business as usual at NWC. The 2021 financial statements, the 2022 initial forecast, and a ratio analysis for 2021 and the 2022 initial forecast are given in Table IC 17.1. Assume the firms cost of goods sold is 50% of sales.
e. Initially, some NWC managers questioned whether the new facility expansion was necessary, especially as it results in increasing net fixed assets from $500 million to $700 million (a 40% increase). However, after extensive discussions about NWC needing to position itself for future growth and being flexible and competitive in todays marketplace, NWCs top managers agreed that the expansion was necessary. Among the issues raised by opponents was that NWCs fixed assets were being operated at only 85% of capacity. Assuming that its fixed assets were operating at only 85% of capacity, by how much could sales have increased, both in dollar terms and in percentage terms, before NWC reached full capacity?
Financial Statements and Other Data on NWC (millions of dollars) TABLE IC 17.1
A. Balance Sheets | 2021 | 2022E |
Cash and equivalents | $ 20 | $ 25 |
Accounts receivable | 240 | 300 |
Inventories | 240 | 300 |
Total current assets | $ 500 | $ 625 |
Net fixed assets | 500 | 625 |
Total assets | $ 1,000 | $ 1,250 |
Accounts payable and accrued liabilities | $ 100 | $ 125 |
Notes payable | 100 | 190 |
Total current liabilities | $ 200 | $ 315 |
Long-term debt | 100 | 180 |
Common stock | 500 | 500 |
Retained earnings | 200 | 255 |
Total liabilities and equity | $1,000 | $1,250 |
B. Income Statements | 2021 | 2022E |
Sales | $2,000.00 | $2,500.00 |
Variable costs | 1,200.00 | 1,500.00 |
Fixed costs | 700.00 | 875.00 |
Earnings before interest and taxes (EBIT) | $ 100.00 | $ 125.00 |
Interest | 16.00 | 20.00 |
Earnings before taxes (EBT) | $ 84.00 | $ 105.00 |
Taxes (25%) | 21.00 | 26.25 |
Net income | $ 63.00 | $ 78.75 |
Dividends (30%) | $ 18.90 | $ 23.63 |
Addition to retained earnings | $ 44.10 | $ 55.13 |
C. Key Ratios | NWC (2021) | NWC (2022E) | Industry | Comment |
Basic earning power | 10.00% | 10.00% | 20.00% | |
Profit margin | 3.15 | 3.15 | 4.00 | |
Return on equity | 9.00 | 10.43 | 15.60 | |
Days sales outstanding (365 days) | 43.80 days | 43.80 days | 32.00 days | |
Inventory turnover | 4.17 | 4.17 | 6.00 | |
Fixed assets turnover | 4.00 | 4.00 | 5.00 | |
Total assets turnover | 2.00 | 2.00 | 2.50 | |
Total liabilities/assets | 30.00% | 39.60% | 36.00% | |
Times interest earned | 6.25 | 6.25 | 9.40 | |
Current ratio | 2.50 | 1.98 | 3.00 | |
Payout ratio | 30.00% | 30.00% | 30.00% |
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