INTEGRATED CASE 2 Iaonenlt NEW WORLD CHEMICALS INC. 17-16 FINANCIAL FORECASTING Sue Wilson, the new financial manager of New World Chemicals (NWC), a California producer of specialized forecast for 2019. NWC's 2018 sales w for use in fruit orchards, must prepare a formal financial increase for 2019. Wilson thinks the com billion, and the marketing department is forecasting a 25% The first step "bu forecast was to assume that vas operating at full capacity in 2018, but she for 2018 and the 2019 WC. The 2018 financial satios would remain unchanged and that it would be Assume that you were r develop the formal financial hired as Wilson's assistant and that your first major task is to help her Assume (1) that NWC was operating at full not sure. s usual" forecast are given in Table IC 17e 2019 initial forecast, and a ratio analysis recast. She asks you to begin by answering the following questions: a assets must grow at the same rate as sales, (3) tyin 2018 with respect to all assets, (2) that all will grow at the same rate as sales, and (4) that the 201unts payable and accd nayout will be requirements to those conditions, what would the AFN equation predict the company's financial Consultationswith several key managers within NWC, including production, inventory, and receiv- also maintained profit margin a be for the coming year? able managers, have yielded some very useful information. 1. NWC's high DSO is largely due to one significant customer who battled through some hardships the past 2 years but who appears to be financia strong cash flow As a result, NWC's accounts receivable manahelthy again and is geereceivables enough for rm to lower a calculated DSO of 34 days without adversely affecting sales. 2. NWC was operating slightly below capacity, but its forecasted growth will require a new facility, which is expected to increase NWC's net fixed assets to $700 million. 3. A relatively new inventory management system (installed last year) has taken some time to catch on and to operate efficiently. NWC's inventory turnover improved slightly last year, but this year NWC expects even more improvement as inventories decrease and inventory turnover is expected to rise to 10X. Incorporate that information into the 2019 initial forecast results, as these adjustments to the ini- tial forecast represent the final forecast for 2019. (Hint: Total assets do not change from the initial forecast.) Calculate NWC's forecasted ratios based on its final forecast and compare them with the company's 2018 historical ratios, the 2019 initial forecast ratios, and the industry averages. How does NWC compare with the average firm in its industry, and is the company's financial position expected to improve during the coming year? Explain. d. Based on the final forecast, calculate NWC's free cash flow for 2019. How does this FCF differ from the FCF forecasted by NWC's initial "business as usual" forecast? C Initially, some NWC managers questioned whether the new facility expansion was necessary, espe- cially 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 today's marketplace, NWC's top managers agreed that the expan- sion was necessary. Among the issues raised by opponents was that NWC's fixed assets were being operated at only 85% of capacity. Assuming that its fixed assets were operating at only 85% of capac- ity,by how much could sales have increased, both in dollar terms and in percentage terms, before NWC reached full capacity? e. How would changes in the following items affect the AFN: (1) the dividend payout ratio, (2) the profit margin, (3) the capital intensity ratio, and (4) NWC beginning to buy from its suppliers on terms that permit it to pay after 60 days rather than after 30 days? (Consider each item separately and hold all other things constant.) f. 2019E 17.1 Financial Statements and Other Data on NWC (Millions of Dollars) 2018 25 A. Balance Sheets 20 300 Cash and equivalents. 24C 300 Accounts receivable 24C s 625 Inventories S 500 625 Total current assets 500 $1,250 Net fixed assets $1,000 Total assets 125 s 100 19C Accounts payable and accrued liabilities 100 $315 Notes payable $ 200 190 Total current liabilities 100 500 Long-term debt 500 Common stock 245 200 Retained earnings $1,250 $1,000 Total liabilities and equity 2019E 2018 B. Income Statements $2,500.00 $2,000.00 Sales 1,500.00 1,200.00 Variable costs 875.00 700.00 Fixed costs $ 125.00 S 100.00 Earnings before interest and taxes (EBIT) 16.00 16.00 Interest 109.00 84.00 Earnings before taxes (EBT) 43.60 33.60 Taxes (40 %) $ 65.40 S 50.40 Net income 19.62 15.12 Dividends (30%6) 45.78 35.28 Addition to retained earnings Industry Comment NWC (2019E) NWC (2018) C. Key Ratios 10.00 % 10.00% 20.00% Basic earning power 2.62 2.52 4.00 Profit margin 7.20 8.77 Return on equity 15.60 43.80 days 43.80 days Days sales outstanding (365 days) 32.00 days 8.33X 8.33X Inventory turnover 11.00x Fixed assets turnover 4.00 4.00 5.00 Total assets turnover 2.00 2.00 2.50 Total liabilities/assets 30.00% 40.40% 36.00% Times interest earned 6.25X 7.81X 9.40X Current ratio 2.50 1,99 3.00 Payout ratio 30.00% 30.00% 30.00% INTEGRATED CASE 2 Iaonenlt NEW WORLD CHEMICALS INC. 17-16 FINANCIAL FORECASTING Sue Wilson, the new financial manager of New World Chemicals (NWC), a California producer of specialized forecast for 2019. NWC's 2018 sales w for use in fruit orchards, must prepare a formal financial increase for 2019. Wilson thinks the com billion, and the marketing department is forecasting a 25% The first step "bu forecast was to assume that vas operating at full capacity in 2018, but she for 2018 and the 2019 WC. The 2018 financial satios would remain unchanged and that it would be Assume that you were r develop the formal financial hired as Wilson's assistant and that your first major task is to help her Assume (1) that NWC was operating at full not sure. s usual" forecast are given in Table IC 17e 2019 initial forecast, and a ratio analysis recast. She asks you to begin by answering the following questions: a assets must grow at the same rate as sales, (3) tyin 2018 with respect to all assets, (2) that all will grow at the same rate as sales, and (4) that the 201unts payable and accd nayout will be requirements to those conditions, what would the AFN equation predict the company's financial Consultationswith several key managers within NWC, including production, inventory, and receiv- also maintained profit margin a be for the coming year? able managers, have yielded some very useful information. 1. NWC's high DSO is largely due to one significant customer who battled through some hardships the past 2 years but who appears to be financia strong cash flow As a result, NWC's accounts receivable manahelthy again and is geereceivables enough for rm to lower a calculated DSO of 34 days without adversely affecting sales. 2. NWC was operating slightly below capacity, but its forecasted growth will require a new facility, which is expected to increase NWC's net fixed assets to $700 million. 3. A relatively new inventory management system (installed last year) has taken some time to catch on and to operate efficiently. NWC's inventory turnover improved slightly last year, but this year NWC expects even more improvement as inventories decrease and inventory turnover is expected to rise to 10X. Incorporate that information into the 2019 initial forecast results, as these adjustments to the ini- tial forecast represent the final forecast for 2019. (Hint: Total assets do not change from the initial forecast.) Calculate NWC's forecasted ratios based on its final forecast and compare them with the company's 2018 historical ratios, the 2019 initial forecast ratios, and the industry averages. How does NWC compare with the average firm in its industry, and is the company's financial position expected to improve during the coming year? Explain. d. Based on the final forecast, calculate NWC's free cash flow for 2019. How does this FCF differ from the FCF forecasted by NWC's initial "business as usual" forecast? C Initially, some NWC managers questioned whether the new facility expansion was necessary, espe- cially 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 today's marketplace, NWC's top managers agreed that the expan- sion was necessary. Among the issues raised by opponents was that NWC's fixed assets were being operated at only 85% of capacity. Assuming that its fixed assets were operating at only 85% of capac- ity,by how much could sales have increased, both in dollar terms and in percentage terms, before NWC reached full capacity? e. How would changes in the following items affect the AFN: (1) the dividend payout ratio, (2) the profit margin, (3) the capital intensity ratio, and (4) NWC beginning to buy from its suppliers on terms that permit it to pay after 60 days rather than after 30 days? (Consider each item separately and hold all other things constant.) f. 2019E 17.1 Financial Statements and Other Data on NWC (Millions of Dollars) 2018 25 A. Balance Sheets 20 300 Cash and equivalents. 24C 300 Accounts receivable 24C s 625 Inventories S 500 625 Total current assets 500 $1,250 Net fixed assets $1,000 Total assets 125 s 100 19C Accounts payable and accrued liabilities 100 $315 Notes payable $ 200 190 Total current liabilities 100 500 Long-term debt 500 Common stock 245 200 Retained earnings $1,250 $1,000 Total liabilities and equity 2019E 2018 B. Income Statements $2,500.00 $2,000.00 Sales 1,500.00 1,200.00 Variable costs 875.00 700.00 Fixed costs $ 125.00 S 100.00 Earnings before interest and taxes (EBIT) 16.00 16.00 Interest 109.00 84.00 Earnings before taxes (EBT) 43.60 33.60 Taxes (40 %) $ 65.40 S 50.40 Net income 19.62 15.12 Dividends (30%6) 45.78 35.28 Addition to retained earnings Industry Comment NWC (2019E) NWC (2018) C. Key Ratios 10.00 % 10.00% 20.00% Basic earning power 2.62 2.52 4.00 Profit margin 7.20 8.77 Return on equity 15.60 43.80 days 43.80 days Days sales outstanding (365 days) 32.00 days 8.33X 8.33X Inventory turnover 11.00x Fixed assets turnover 4.00 4.00 5.00 Total assets turnover 2.00 2.00 2.50 Total liabilities/assets 30.00% 40.40% 36.00% Times interest earned 6.25X 7.81X 9.40X Current ratio 2.50 1,99 3.00 Payout ratio 30.00% 30.00% 30.00%