Objectives:
· Prepare cash budgets and pro forma financial statements to consolidate understanding of the fundamentals of financial forecasting and the relationship between the two basic forecasting techniques – cash budgeting and pro forma financial statement analysis
· Assess whether the lender should issue the loan to a profitable firm that experiences a bottleneck problem in its production
· Practice critical evaluation of assumptions underlying financial forecasts
· Provide a preliminary analysis on topics like share repurchases and dividend payouts
Questions:
1. Why can’t a profitable company like Jackson repay its loan on time? What major company developments between August 2012 and May 2013 contribute to this situation? Prepare a sources and uses of funds statement for August 2012 through May 2013.
2. Why does the company need a new loan? How urgent is the need for additional borrowing?
3. Prepare monthly cash budget and pro forma income statements and balance sheets for the last four months of the fiscal year. Do the cash budgets and pro forma financial statements yield the same results? Why or why not?
4. Based on your forecasts and analysis of Jackson’s credit, is the company able to repay its loan at the end of the fiscal year? What are the risks associated with the proposed loan?
5. Critically evaluate the assumptions on which your forecasts are based and perform sensitivity analysis on the fiscal year-end cash balance when sales forecasts vary from expectations.
6. Should the bank extend the maturity of the current loan and approve the additional loan? What terms and conditions should the bank impose to reduce the risks of the loan to the bank?
7. Why did the company repurchase a substantial fraction of its outstanding common stocks? What’s the impact of the repurchase on Jackson’s financial condition?
8. Critically assess the company’s proposed dividend payout in September 2013. Should the bank agree with the payout? What seems to be an appropriate amount?
1
Capital Structure
2
Capital Structure Basics
What is capital structure?
The firm’s mixture of debt and equity
How do firms raise funds?
Internally (Profits)
Externally (Debt and Equity Sources)
3
Sources of Funds, Non-Financial U.S. Corporations
4
How do we define debt?
Debt / Total Assets
(1,579 + 2,725) / 7,856 = 0.55
LT Liabilities / (LT Liabilities + Equity)
2,725 / (2,725 + 3,552) = 0.43
Is this too much?
Too little? Just right?
5
Basic Definitions
V = value of firm
FCF = free cash flow
WACC = weighted average cost of capital
rs and rd are costs of stock and debt
ws and wd are percentages of the firm that are financed with stock and debt
Also account for preferred stock (ps)
6
Estimating WACC
Stock price is $50
3 million shares of stock
$25 million of preferred stock
$75 million of debt
Cost of debt is 10%
Cost of preferred stock is 9%
Cost of common stock is 12.8%
7
Estimating Weights (Continued)
Vs = $50(3 million) = $150 million
Vps = $25 million
Vd = $75 million
V = Total value = ?
$150 + $25 + $75 = $250 million
8
Estimating Weights (Continued)
ws = $150/$250 = 0.6
wps = $25/$250 = 0.1
wd = $75/$250 = 0.3
These are market value weights
Target weights usually close (here the same)
But, often market weights temporarily deviate from targets due to changes in stock prices
9
What’s the WACC using the target weights?
WACC = wdrd(1 – T)
+ wpsrps
+ wsrs
WACC = 0.3(10%)(1 − 0.4)
+ 0.1(9%)
+ 0.6(12.8%)
WACC = 10.38% ≈ 10.4%
10
Why (1-T) for rd?
Interest expense is tax deductible
Interest Expense = $1,200 = Total Debt * rd
Tax Savings for Firm L = Interest Expense * Tax Rate = $1,200 * 0.40 = $480
Firm U
Firm L
EBIT
$3,000
$3,000
Interest
0
1,200
EBT
$3,000
$1,800
Taxes (40%)
1 ,200
720
NI
$1,800
$1,080
11
Why (1-T) for rd?
Levered firm saves $480 in taxes, so total cost of debt is $1,200 – $480 = $720
In general, firm’s actual cost of debt:
(Total Debt * rd) – [(Total Debt * rd) * T]
= Total Debt * [rd – (rd * T)]
= Total Debt * [rd * (1 – T)]
12
What factors influence a company’s WACC?
Uncontrollable factors:
Market conditions, especially interest rates
The market risk premium
Tax rates
Controllable factors:
Capital structure policy
Dividend policy
Investment policy (firms with riskier projects generally have a higher cost of equity)
13
How can capital structure affect value?
V
=
∑
∞
t=1
FCFt
(1 + WACC)t
The impact of capital structure on value depends upon the effect of debt on:
WACC and FCF
Sound familiar?
14
The Effect of Additional
Debt on WACC
Debtholders have a prior claim on cash flows relative to stockholders
Debtholders’ “fixed” claim increases risk of stockholders’ “residual” claim
Cost of stock, rs, goes up
Firms can deduct interest expenses
Reduces the taxes paid
Frees up more cash for payments to investors
Reduces after-tax cost of debt
(Continued…)
15
The Effect on WACC (Continued)
Debt increases risk of bankruptcy
Causes pre-tax cost of debt, rd, to increase
Adding debt increases percent of firm financed with low-cost debt (wd) and decreases percent financed with high-cost equity (ws)
Net effect on WACC = uncertain
16
The Effect of Additional Debt on FCF
Additional debt increases the probability and costs of bankruptcy
Bankruptcy costs:
Direct: Legal fees, “fire” sales, etc.
Indirect: Lost customers, reduction in productivity, reduction in credit (i.e., accounts payable)
17
The Effect of Additional Debt on Managerial Behavior
Reductions in agency costs
Debt “pre-commits” (or “bonds”) free cash flow for use in making interest payments
Managers less likely to waste FCF on perquisites or non-value adding acquisitions
Increases in agency costs
Debt can make managers too risk-averse, causing “underinvestment” in risky but positive NPV projects
18
Business Risk vs
Financial Risk
Business risk:
Uncertainty in future EBIT, NOPAT, and ROIC
Depends on business factors such as competition, operating leverage, etc.
Financial risk:
Additional business risk concentrated on common stockholders when financial leverage is used
Depends on the amount of debt and preferred stock financing
19
Consider Two Hypothetical Firms Identical Except for Debt
Firm U
Firm L
Capital
$20,000
$20,000
Debt
$0
$10,000 (12% rate)
Equity
$20,000
$10,000
Tax rate
40%
40%
EBIT
$3,000
$3,000
NOPAT
$1,800
$1,800
ROIC
9%
9%
20
Impact of Leverage on Returns
Firm U
Firm L
EBIT
$3,000
$3,000
Interest
0
1,200
EBT
$3,000
$1,800
Taxes (40%)
1,200
720
NI
$1,800
$1,080
ROIC
9.0%
9.0%
ROE (NI/Equity)
9.0%
10.8%
21
Why does leveraging increase return?
More cash goes to investors of Firm L
Total dollars paid to investors:
U: NI = $1,800
L: NI + Int = $1,080 + $1,200 = $2,280
Taxes paid:
U: $1,200
L: $720
22
Impact of Leverage on Returns if EBIT Falls
Firm U
Firm L
EBIT
$2,000
$2,000
Interest
0
1,200
EBT
$2,000
$800
Taxes (40%)
800
320
NI
$1,200
$480
ROIC
6.0%
6.0%
ROE
6.0%
4.8%
Leverage magnifies risk and return!
23
Capital Structure Theory
Modigliani and Miller (MM) theory
Zero taxes
Corporate taxes
Corporate and personal taxes
Trade-off theory
Signaling theory
Pecking order
Debt financing as a managerial constraint
Windows of opportunity
24
MM Theory: Zero Taxes
Firm U
Firm L
EBIT
$3,000
$3,000
Interest
0
1,200
NI
$3,000
$1,800
CF to shareholder
$3,000
$1,800
CF to debtholder
0
$1,200
Total CF
$3,000
$3,000
Notice that the total CF are identical for both firms.
25
MM Results: Zero Taxes
MM assume:
(1) no transactions costs (e.g. taxes, bankruptcy, brokerage)
(2) no restrictions or costs to short sales
(3) individuals can borrow at the same rate as corporations
Firm U:
No taxes or debt, so 100% of EBIT to stockholders
Firm L:
Debtholders receive rd*D
Stockholders receive EBIT – (rd*D)
Together: rd*D + EBIT – (rd*D) = EBIT
26
MM Results: Zero Taxes
MM prove that if the total CF to investors of Firm U and Firm L are equal, then the total values of Firm U and Firm L are equal:
VL = VU
Because FCF and values of firms L and U are equal, their WACCs are equal
Therefore, capital structure is irrelevant
27
MM Theory: Corporate Taxes
Corporate tax laws allow interest to be deducted, which reduces taxes paid by levered firms
Therefore, more CF goes to investors and less to taxes when leverage is used
In other words, the debt “shields” some of the firm’s CF from taxes
28
MM Result: Corporate Taxes
MM show that the total CF to Firm L’s investors is equal to the total CF to Firm U’s investor plus an additional amount due to interest deductibility:
CFL = CFU + rdDT
What is the value of these cash flows?
29
MM Result: Corporate Taxes
CFL = CFU + rdDT
1) Value of CFU = VU
2) Value of rdDT = PV (Tax Shield)
PV (Tax Shield) = Tax Shield / rd
Tax Shield = Int Payment * Corp Tax Rate
Int Payment = Debt * rd
Then, PV (Tax Shield) = (Debt*rd*Tax Rate) / rd
Therefore, VL = VU + (Debt * Tax Rate)
30
MM Result: Corporate Taxes
If T=40%, then every dollar of debt adds 40 cents of extra value to firm
What is optimal capital structure?
31
Value of Firm, V
0
Debt
VL
VU
Under MM with corporate taxes, the firm’s value increases continuously as more and more debt is used
TD
MM relationship between value and debt when corporate taxes are considered
32
Miller’s Theory: Corporate and Personal Taxes
Personal taxes lessen the advantage of corporate debt:
Corporate taxes favor debt financing since corporations can deduct interest expenses
Personal taxes favor equity financing, since no gain is reported until stock is sold, and long-term gains are taxed at a lower rate
33
Miller’s Model with Corporate and Personal Taxes
VL = VU + 1− D
Tc = corporate tax rate
Td = personal tax rate on debt income
Ts = personal tax rate on stock income
(1 – Tc)(1 – Ts)
(1 – Td)
34
Tc = 40%, Td = 30%,
and Ts = 12%
VL = VU + 1− D
= VU + (1 – 0.75)D
= VU + 0.25D
Value rises with debt; each $1 increase in debt raises L’s value by $0.25
(1 – 0.40)(1 – 0.12)
(1 – 0.30)
35
Trade-off Theory
MM theory ignores bankruptcy (financial distress) costs, which increase as more leverage is used
At low leverage levels, tax benefits outweigh bankruptcy costs
At high levels, bankruptcy costs outweigh tax benefits
An optimal capital structure exists that balances these costs and benefits
36
Tax Shield vs. Cost of Financial Distress
Value of Firm, V
0
Debt
VL
VU
Tax Shield
Distress Costs
37
Signaling Theory
MM assumed that investors and managers have the same information
But, managers often have better information:
If stock is overvalued?
Issue Stocks (SEOs)
If stock undervalued?
Sell bonds
Investors understand this, so view new stock sales as a negative signal
38
Pecking Order Theory
1) Use internally generated funds (no flotation costs or negative signals)
2) Issue debt (lower flotation costs than equity and not negative signal)
3) Issue equity (high flotation costs and negative signal)
39
Debt Financing and Agency Costs
One agency problem is that managers can use corporate funds for non-value maximizing purposes (i.e. perks and empire-building)
The use of financial leverage:
Bonds “free cash flow”
Forces discipline on managers to avoid perks and non-value adding acquisitions
40
Debt Financing and Agency Costs (continued)
A second agency problem is the potential for “underinvestment”
The use of financial leverage:
Increases risk and costs of financial distress
Therefore, managers may avoid risky projects even if they have positive NPVs
41
Windows of Opportunity: Market Timing
Managers try to “time the market” when issuing securities
They issue equity when the market is “high” and after big stock price run ups
They issue debt when the stock market is “low” and when interest rates are “low”
They issue short-term debt when the term structure is upward sloping and long-term debt when it is relatively flat
42
Implications for Managers
Take advantage of tax benefits by issuing debt, especially if the firm has:
High tax rate
Stable sales
Low operating leverage
43
Implications for Managers (Continued)
Avoid financial distress costs by maintaining excess borrowing capacity, especially if the firm has:
Volatile sales
High operating leverage
Many potential investment opportunities
Special purpose assets (instead of general purpose assets that make good collateral)
44
Implications for Managers (Continued)
Avoid issuing equity if actual prospects are better than the market perceives (in this case, firm is undervalued)
Always consider the impact of capital structure choices on lenders’ and rating agencies’ attitudes
45
Choosing the Optimal Capital Structure: Example
β = 1.0; rf = 6%; RPM = 6%
Cost of equity using CAPM:
rs = rRF +b (RPM)= 6% + 1(6%) = 12%
Currently has no debt: wd = 0%
WACC = rs = 12%
Tax rate is T = 40%
46
Current Value of Operations
Expected FCF = $30 million
Firm expects zero growth: g = 0
Vop = [FCF(1+g)]/(WACC − g)
Vop = [$30(1+0)]/(0.12 − 0)
Vop = $250 million
47
Other Data for Valuation Analysis
Company has no ST investments
Company has no preferred stock
10,000,000 shares outstanding
48
Current Valuation Analysis
Vop
$250
+ ST Inv.
0
VTotal
$250
− Debt
0
S
$250
÷ n
10
P
$25.00
49
Investment bankers provided estimates of rd for different capital structures
wd
0%
20%
30%
40%
50%
rd
0.0%
8.0%
8.5%
10.0%
12.0%
If company recapitalizes, it will use proceeds from debt issuance to repurchase stock.
50
The Cost of Equity at Different Levels of Debt: Hamada’s Formula
Theory implies that beta changes with leverage (leverage magnifies risk)
βU is the beta of a firm when it has no debt (the unlevered beta)
β = βU [1 + (1 – T)(wd/ws)]
51
The Cost of Equity for wd = 20%
Use Hamada’s equation to find beta:
β = βU [1 + (1 – T)(wd/ws)]
= 1.0 [1 + (1-0.4) (20% / 80%) ]
= 1.15
Use CAPM to find the cost of equity:
rs= rRF + βL (RPM)
= 6% + 1.15 (6%) = 12.9%
52
The WACC for wd = 20%
WACC = wd (1-T) rd + ws rs
WACC = 0.2 (1 – 0.4) (8%) + 0.8 (12.9%)
WACC = 11.28%
Repeat this for all capital structures under consideration
53
Beta, rs, and WACC
wd
0%
20%
30%
40%
50%
rd
0.0%
8.0%
8.5%
10.0%
12.0%
ws
100%
80%
70%
60%
50%
b
1.000
1.150
1.257
1.400
1.600
rs
12.00%
12.90%
13.54%
14.40%
15.60%
WACC
12.00%
11.28%
11.01%
11.04%
11.40%
The WACC is minimized for wd = 30%. This is the optimal capital structure.
Remember: PV increases as discount rate decreases!
54
Corporate Value for wd = 30%
Vop = [FCF(1+g)]/(WACC − g)
Vop = [$30(1+0)]/(0.1101 − 0)
Vop = $272.48 million
Debt = DNew = wd Vop
Debt = 0.30(272.48) = $81.74 million
Equity = S = ws Vop
Equity = 0.70(272.48) = $190.74 million
55
Value of Operations, Debt, and Equity
wd
0%
20%
30%
40%
50%
rd
0.0%
8.0%
8.5%
10.0%
12.0%
ws
100%
80%
70%
60%
50%
b
1.000
1.150
1.257
1.400
1.600
rs
12.00%
12.90%
13.54%
14.40%
15.60%
WACC
12.00%
11.28%
11.01%
11.04%
11.40%
Vop
$250.00
$265.96
$272.48
$271.74
$263.16
D
$0.00
$53.19
$81.74
$108.70
$131.58
S
$250.00
$212.77
$190.74
$163.04
$131.58
Value of operations is maximized at wd = 30%.
56
Anatomy of a Recapitalization: Before Issuing Debt
Before Debt
Vop
$250
+ ST Inv.
0
VTotal
$250
− Debt
0
S
$250
÷ n
10
P
$25.00
Total stockholder
wealth: S + Cash Used to Repur.
$250
57
Issue Debt (wd = 30%), But Before Repurchase
WACC decreases to 11.01%
Vop increases to $272.48
Firm temporarily has short-term investments of $81.74 (until it uses these funds to repurchase stock)
Debt is now $81.74
58
Anatomy of a Recap: After Debt, but Before Repurchase
Before Debt
After Debt, Before Rep.
Vop
$250
$272.48
+ ST Inv.
0
81.74
VTotal
$250
$354.22
− Debt
0
81.74
S
$250
$272.48
÷ n
10
10
P
$25.00
$27.25
Total stockholder
wealth: S + Cash Used to Repur.
$250
$272.48
59
Remaining Number of Shares After Repurchase
DOld is amount of debt the firm initially has, DNew is amount after issuing new debt
If all new debt is used to repurchase shares, then total dollars used equals
(DNew – DOld) = ($81.74 – $0) = $81.74
nPrior is number of shares before repurchase, nPost is number after. Total shares remaining:
nPost = nPrior – (DNew – DOld)/P
nPost = 10 mil – ($81.74 mil/$27.25)
nPost = 7 million
60
Anatomy of a Recap: After Rupurchase
Before Debt
After Debt, Before Rep.
After Rep.
Vop
$250
$272.48
$272.48
+ ST Inv.
0
81.74
0
VTotal
$250
$354.22
$272.48
− Debt
0
81.74
81.74
S
$250
$272.48
$190.74
÷ n
10
10
7
P
$25.00
$27.25
$27.25
Total stockholder
wealth: S + Cash Used to Repur.
$250
$272.48
$272.48
61
Key Points
ST investments fall because they are used to repurchase stock
Stock price is unchanged
Value of equity falls from $272.48 to $190.74 because firm no longer owns the ST investments
Wealth of shareholders remains at $272.48 because shareholders now directly own the funds that were held by firm in ST investments
62
Intrinsic Stock Price Maximized at Optimal Capital Structure
wd
0%
20%
30%
40%
50%
rd
0.0%
8.0%
8.5%
10.0%
12.0%
ws
100%
80%
70%
60%
50%
b
1.000
1.150
1.257
1.400
1.600
rs
12.00%
12.90%
13.54%
14.40%
15.60%
WACC
12.00%
11.28%
11.01%
11.04%
11.40%
Vop
$250.00
$265.96
$272.48
$271.74
$263.16
D
$0.00
$53.19
$81.74
$108.70
$131.58
S
$250.00
$212.77
$190.74
$163.04
$131.58
n
10
8
7
6
5
P
$25.00
$26.60
$27.25
$27.17
$26.32
63
Optimal Capital Structure
wd = 30% gives:
Highest corporate value
Lowest WACC
Highest stock price per share
But wd = 40% is close (optimal range is fairly flat)
image1
image2
Exhibit 1
| Exhibit 1 | Month | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| Forecast as of | September | 2 | 0 | 12 | Actual | Forecast as of | May | 20 | 1 | 3 | ||||||||||||||||||||||||||||||||||||||||||||
| October | 6 | 50 | 8 | 6, | 4 | 21 | ||||||||||||||||||||||||||||||||||||||||||||||||
| November | 6,21 | 9 | 6,302 | |||||||||||||||||||||||||||||||||||||||||||||||||||
| December | 6, | 25 | 6,009 | |||||||||||||||||||||||||||||||||||||||||||||||||||
| January | 6,0 | 7 | 6,170 | |||||||||||||||||||||||||||||||||||||||||||||||||||
| February | 5,996 | 6,006 | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| March | 6,291 | 5,197 | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| April | 6,515 | 4,1 | 65 | |||||||||||||||||||||||||||||||||||||||||||||||||||
| 6,832 | 3, | 744 | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| Eight months total | 50, | 685 | 44,0 | 14 | ||||||||||||||||||||||||||||||||||||||||||||||||||
| June | 6,759 | 12,681 | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| July | 6,6 | 45 | 7, | 37 | ||||||||||||||||||||||||||||||||||||||||||||||||||
| August | 6, | 47 | 7,201 | |||||||||||||||||||||||||||||||||||||||||||||||||||
| 6, | 433 | 7,394 | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| Twelve months total | 26,315 | 34 | 650 | |||||||||||||||||||||||||||||||||||||||||||||||||||
| Fiscal year total | 77,000 | 78,664 |
Exhibit 2
| Exhibit 2 Balance Sheets, 2012-2013 (thousands of dollars) | |||||||||||||||||||||||
| Cash | 8,350 | 3,328 | 3,5 | 23 | 4,5 | 11 | 4,239 | 4,878 | 5,182 | 3,962 | 6,277 | 4,994 | |||||||||||
| Accounts receivablea | 5,793 | 5,969 | 6,421 | 5,851 | 5, | 60 | 3,365 | 3,744 | |||||||||||||||
| Inventory | 7,1 | 54 | 7,364 | 7, | 52 | 7,219 | 7,277 | 7,097 | 7,529 | 8,371 | 11,234 | 12,163 | |||||||||||
| Current assets | 21,297 | 16,661 | 17, | 46 | 17, | 58 | 17,525 | 18,145 | 18,317 | 17,530 | 20,8 | 76 | 20,901 | ||||||||||
| Gross PP&E | 45, | 500 | |||||||||||||||||||||
| Accumulated depreciationb | 30,368 | 30,488 | 30,608 | 30, | 728 | 30,848 | 30,968 | 31,088 | 31,208 | 31,328 | 31, | 448 | |||||||||||
| Net PP&E | 15,132 | 15,012 | 14,892 | 14,772 | 14,652 | 14,532 | 14,412 | 14,292 | 14,172 | 14,052 | |||||||||||||
| Prepaid expenses | 242 | ||||||||||||||||||||||
| Total assets | 36,671 | 31,731 | 32,383 | 32,3 | 98 | 32,224 | 32, | 729 | 32,794 | 31, | 868 | 35,094 | 35,007 | ||||||||||
| Accounts payablec | 4,977 | 5,347 | 5,352 | 5,1 | 10 | 5, | 130 | 5,162 | 5,122 | 6,223 | |||||||||||||
| Notes payable, bank | 5,000 | ||||||||||||||||||||||
| Accrued taxesd | 252 | 174 | 331 | 107 | 269 | 417 | 140 | 216 | 273 | ||||||||||||||
| Other accrued expenses | 1,500 | 1,542 | 1,142 | ||||||||||||||||||||
| Customer advance payments | 1,651 | 1, | 200 | 1,200 | 800 | 2,700 | |||||||||||||||||
| Current liabilities | 8,380 | 13,394 | 13,714 | 13,425 | 12,959 | 13,141 | 12,921 | 12,204 | 15,281 | 15,084 | |||||||||||||
| Shareholders’ equity | 28,291 | 18,337 | 18,668 | 18,973 | 19,265 | 19,588 | 19,874 | 19,664 | 19,813 | 19,923 | |||||||||||||
| Total liabilities and equity | |||||||||||||||||||||||
| a Selling term of net 30 days. | |||||||||||||||||||||||
| b Depreciation of $ | 120 | ||||||||||||||||||||||
| c Purchase terms of net 30 days. | |||||||||||||||||||||||
| d Outstanding taxes on 2012 fiscal year income were due January 15, 2013. On December 15, 2011, March 15, 2012, June 15, 2012, and September 15, 2012, payments of 2 | 5% |
Exhibit 3
| Exhibit 3 Income Statements, 2012-2013 (thousands of dollars) | |||||||||||||
| 2012 August | 2012 September | Fiscal Year Ending 09/30/2012 | 2012 October | 2012 November | 2012 December | 2013 January | 2013 February | 2013 March | 2013 April | 2013 May | Eight Months Total | ||
| Net sales | 6, | 321 | 71,642 | 4, | 165 | ||||||||
| COGS | 4,727 | 56,955 | 5,003 | 4,914 | 4,695 | 4,815 | 4,692 | 4,087 | 3,215 | 2,876 | 34,297 | ||
| Gross profit | 1,327 | 1,242 | 14,687 | 1,418 | 1,388 | 1,314 | 1,355 | 1,110 | 950 | 9,717 | |||
| Operating expenses | 773 | 763 | 9,509 | 777 | 788 | 733 | 587 | 566 | 5,608 | ||||
| Depreciation and amortization | 1,440 | 960 | |||||||||||
| Interest expensea | |||||||||||||
| Interest income | |||||||||||||
| Profit (loss) before tax | 447 | 373 | 3,858 | 502 | 461 | 443 | 489 | 289 | 225 | 167 | 3,009 | ||
| Income taxesc | 152 | 127 | 1,312 | 171 | 1 | 57 | 151 | 166 | 147 | 1,023 | |||
| Net income | 295 | 246 | 2,546 | 304 | 293 | 323 | 286 | 191 | 148 | 111 | 1,986 | ||
| Dividend | 400 | ||||||||||||
| a 6% annualized interest rate charged on outstanding bank loans. | |||||||||||||
| b 2% annualized rate of return on beginning monthly cash balances. | |||||||||||||
| c The federal tax rate on all earnings was 34%. |
Table 1
| Table 1: Sources and | Uses of Funds | ||
| Sources of Funds | |||
| Increase in bank debt | |||
| Decrease in cash | 3,356 | ||
| Decrease in accounts receivable | 2,049 | ||
| Increase in retained earnings | 1,632 | ||
| Decrease in net fixed assets | 1,080 | ||
| Increase in customer advances | 1,049 | ||
| Increase in accounts payable | 992 | ||
| Decrease in prepaid expenses | 188 | ||
| Increase in taxes payable | |||
| Total Sources of Funds | 15,367 | <---Check: Total Sources of Funds should equal 15,367 | |
| Stock repurchase | 10,000 | ||
| Inventories | 5,009 | ||
| Decrease in accruals | 358 | ||
| Total Uses of Funds | <---Check: Total Uses of Funds should equal 15,367 |
Table 2
| Table 2: Pro Forma Cash Budget, June to October 2013 (thousands of dollars) | |||||||||
| Beginning Cash Balance | 1,627 | 6,536 | 7,034 | (715) | |||||
| Cash Receipts | |||||||||
| Collections of accounts receivable | 10,881 | 6,474 | |||||||
| Bank loan | 2,400 | ||||||||
| Total cash inflow | 3,752 | 13,284 | 6, | 485 | 7,213 | ||||
| Cash Disbursements | |||||||||
| Payments of accounts payable | 5,200 | ||||||||
| 750 | |||||||||
| Capital expenditure | |||||||||
| Tax payments | 375 | ||||||||
| Interest payments | |||||||||
| Principal payments | 7,400 | ||||||||
| Dividend payments | |||||||||
| Total cash outflow | 7,119 | 8,375 | 5,987 | 14,962 | 5,950 | ||||
| Net cash inflow (outflow) | (3,367) | 4,909 | 498 | (7,749) | 1,444 | ||||
| Ending Cash Balance | <---Check: Ending Cash Balances should equal 1627, 6536, 7034, -715, and 729. |
Table 3
| Table 3: Pro Forma Income Statements, June to October 2013 (thousands of dollars) | |||||
| Four Months Total | |||||
| 7,374 | |||||
| COGSa | 10,850 | 5,810 | 28,280 | ||
| 1,831 | 1,564 | 1,391 | 1,584 | 6,370 | |
| 3,000 | |||||
| Interest expenseb | 124 | ||||
| Interest incomec | |||||
| 944 | 672 | 679 | 2,780 | ||
| Income taxesd | 228 | 231 | 945 | ||
| 623 | 320 | 1,835 | <---Check: Net Income should equal 623, 443, 320, 448, and 1835. | ||
| a: $5,040 imminent reduction of work-in-progress in June, plus $2,440 of abnormal inventory levels spread evenly over four months, plus monthly materials purchases. | |||||
| b 6% annualized interest rate charged on outstanding debt. | |||||
| c 2% annualized rate of return on the cash balance. | |||||
| d 34% tax rate. |
Table 4
| Table 4: Sensitivity Analysis – The Impact of Sales Drop on September Cash Balance | |||||
| Sales Increase / Dropa | |||||
| -1 | 0% | -5% | 10% | ||
| 2400 | (4,646) | (3,281) | (1,915) | (550) | 816 |
| 1800 | (4,046) | (2,681) | (1,315) | 1,416 | |
| 1200 | (3,446) | (2,081) | 2,016 | ||
| 600 | (2,846) | (1,481) | (115) | 1,250 | 2,616 |
| (2,246) | (881) | 1,850 | 3,216 | ||
| a Sales drop is assumed to be evenly distributed over four months. |
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