Answered step by step
Verified Expert Solution
Link Copied!

Question

1 Approved Answer

In the Financial Planning and Forecasting department, Robert was asked to forecast the future cash flows and financial needs of the Ashford Company for 2019

In the Financial Planning and Forecasting department, Robert was asked to forecast the future cash flows and financial needs of the Ashford Company for 2019 and 2020. Specifically, he was asked to determine the financial needs of the Ashford Company for its 2019 and 2020. Initially, he was not sure how to proceed with his analysis but remembered in his finance classes that he needed to set the pro forma financial statements for the analysis.

To set up the pro forma statements and forecast the company's expected financial needs, Bradford decided to seek advice of the company's marketing research department. He was told the most likely sales level for 2019 and 2020 would be similar to the growth rate of 30% achieved in 2018. This estimate was based on the company's market share and analysis of the demand for its products and eventually will drop to 5% in the future.

Financial Planning and Forecasting Procedures

The analytical tool used in forecasting financial needs of a company is based on pro forma financial statements. The preparation of pro forma financial statements involves the following steps:

  1. Project sales revenue for the desired periods.
  2. Project operating expenses (cost of goods sold, selling and administrative, income taxes).
  3. Project assets, liabilities, and shareholders' equity (except retained earnings) needed to support the level of the operations projected in steps 1 and 2.
  4. Determine the cost of financing the capital structure derived in step 3.
  5. Derive the statement of cash flows from the projected income statements and balance sheets. The preparation of pro forma financial statements requires numerous assumptions about the growth rate in sales, cost behavior of various expenses level of investment in working capital fixed assets, and mix of financing. The analyst should study the sensitivity of these statements to the assumptions made and to the impact of different assumptions.

Assumptions for Estimation

To develop the projected financial statements, Robert made the following assumptions:

1. In arriving at the annual EBIT estimates, the depreciation expense of 5% per year would be deducted The annual dollar depreciation expense is based on the needs of the company for future gross fixed assets and is 5% of the total gross fixed assets.

There was no excess capacity or assets. Expenditures on fixed assets would be necessary to replace worn-out equipment and to provide the needed capacity for growth. All fixed and current assets and some of the current liabilities would change in direct proportion to sales. For example; if sales increased by 5%, cash, account receivables, inventory, and spontaneous liabilities would each increase by 5%.

  1. The Ashford's management has desire to maintain its debt and the current capital structure.
  2. Capital structure is the summation of book value debt and the market value of equity. The debt ratio (D/V) is calculated by book value of debt (D) divided by the sum of the book value of debt plus the market value of equity (D+ S).
  3. While holding the capital structure constant would make the analysis easier, he was wondered

what would be the effect of allowing debt-to- and equity ratio to change as the Company would have a financing surplus or deficit.

Mergers and Acquisitions Department

In the Mergers and Acquisitions department, Robert was assigned to the acquisition of The Ashford Company by Best International Corporation (BIC). Specifically, he was asked to determine the price that BIC could offer for the Ashford Company. As a financial analyst, Robert was not sure why BIC was interested in the Ashford Company, since the two companies, not being in the same industry, did not have a synergistic relationship. However, he thought he should do his job and come up with a price offer.

VALUATION MODELS

In theory, there are several valuation models. These models are Discounted Cash Flow, Cash Flow to Equity (CFE) Adjusted Present Value (APV), Market/Book Value, and P/E ratio, which could be used to estimate the value of a firm. Robert was not sure which one to select. He is asking you to explain and show which model is suited for him to use.

Exhibit 1- Ashford Company Income Statement 12,31,2018

Sales

$10,000,000

Less: COST of Sales

8,700,000

Earnings before Depreciation & Taxes

$1,300,000

Less: Depreciation

$200,000

Earnings before Interest & Taxes

$1,100,000

Less: Interest Expense

$100,000

Earnings before Taxes

$1,000,000

Less: Taxes (40%)

$400,000.0

Earnings After Taxes

$600,000.0

Outstanding Shares

1,000,000

EPS

$0.60

Exhibit 2- Ashford Company Balance Sheet 12,31,2018

Cash

$ 400.00

Accounts Payable

$ 500.00

Accounts Receivable

$ 600.00

Inventory

$ 1,200.00

Notes Payable (@ 5%)

$ 500.00

Current Assets

$ 1,800.00

Current Liabilities

$ 1,000.00

Gross Fixed Assets

$ 4,000.00

Long-term Debt (@ 7.5%)

$ 1,000.00

Less: Accumulated

$ (800.00)

Common Stock (1M shares

at par value of $1.00)

$ 1,000.00

Net Fixed Asset

$3,200

Paid-in-capital

$ 1,000.00

Retained Earnings

$ 1,000.00

Total Assets

$ 5,000.00

Total Debt & Equity

$ 5,000.00

Exhibit 3

Financial Data (In Millions)

Company

Ashford

BIC

Debt (Market Value)

$1.00

$10.00

Equity

$3.00

$25.00

Beta

0.3

1.25

Per Share Data:

Earnings per Share

$0.60

$3.25

Dividend per Share

$0.13

$0.65

Stock Price (12/31/2018)

$4.00

$36.50

Exhibit-4 Market Information

Treasuries

Corporate

Securities

Bills

Bonds

Bonds Interest Rate

Yields: in 2018

1%

3%

5%

Market Risk Premium

8.00%

6%

Step by Step Solution

There are 3 Steps involved in it

Step: 1

blur-text-image

Get Instant Access to Expert-Tailored Solutions

See step-by-step solutions with expert insights and AI powered tools for academic success

Step: 2

blur-text-image

Step: 3

blur-text-image

Ace Your Homework with AI

Get the answers you need in no time with our AI-driven, step-by-step assistance

Get Started

Recommended Textbook for

Financial Accounting Reporting Analysis And Decision Making

Authors: Shirley Carlon, Rosina Mcalpine, Chrisann Lee, Lorena Mitrione, Ngaire Kirk, Lily Wong

7th Edition

0730395294, 978-0730395294

More Books

Students also viewed these Accounting questions

Question

How may batch processing be used to improve operational efficiency?

Answered: 1 week ago

Question

Explain the process of MBO

Answered: 1 week ago

Question

=+What about SRI funds? Why, or why not?

Answered: 1 week ago