New Worlds Chemicals Inc.
Assume (1) that NWC was operating at full capacity in 2008 with respect to all assets, (2) that all assets must grow at the same rate as sales, (3) that accounts payable and accrued liabilities also will grow at the same rate as sales, and (4) that the 2008 profit margin and dividend payout will be maintained. Under those conditions what would the AFN equation predict the company’s financial requirements to be for the coming year?
Additional Funds Needed (AFN) are also known as External Funding Required. In the following, the AFN equation is displayed for 2009:
AFN=(A^*/S_0 )∆S-(L^*/S_0 )∆S-M(S_1)(RR)
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(Hint: Total assets do not change from the initial forecast.)
Days sales outstanding (DSO):
Days Sales Outstanding=((Accounts receivables)/Sales)*Days in period
AR=(DSO*Sales)/(Days in period)
Forecasted growth will require a new facility. This will increase NWC´s net fixed assets to $700 million.
The new inventory management system will increase the inventory turnover in 2009 to 10x:
Total assets in 2009 (considering ii) ):
Total current assets=Total assets-Net fixed assets
The total current assets in 2009 will not change in comparison to 2008.
Cash and equivalents in 2009 (considering i), iii), iv) ):
Cash and equivalents=Total current assets-Accounts receivable-Inventories
Cash and equivalents=$550-$233-$250
Cash and equivalents=$67
The following table shows the final forecasted balance sheet for 2009, including the results shown above:
2008 2009E 2009 Final
Cash and equivalents $ 20 $ 25 $ 67
Accounts receivable 240 300 233
Inventories 240 300 250
Total current assets $ 500 $ 625 $ 550
Net fixed assets 500 625 700
Total assets $ 1000 $ 1250 $ 1250
Accounts payable and accrued liabilities $ 100 $ 125 $ 125
Notes payable 100 190 190
Total current liabilities $ 200 $ 315 $ 315
Long-term debt 100 190 190
Common stock 500 500 500
Retained earnings 200 245 245
Total liabilities and equity $ 1000 $ 1250 $ 1250
These changes will not have an impact on the final forecasted income statement for 2009 which will stay the same.
Calculate NWC’s forecasted ratios based on its final forecast and compare them with the company’s 2008 historical ratios, the 2009 initial forecast ratios, and with 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.
As displayed in the following table, the final forecasted ratios of NWC are in general poorer than the industry ratios. Some ratios are within the average of the industry like DSO and the payout ratio; some ratios are slightly poorer than the industry´s average like inventory turnover and total assets turnover. All other ratios of NWC are poorer to the industry´s averages.
NWC (2008) NWC (2009E) NWC (2009 Final) Industry 2008 Comment
Basic earnings power 10.00% 10.00% 10.00% 20.00% Low
Profit margin 2.52 2.62 2.62 4.00 Low
Return on equity 7.20 8.77 8.77 15.60 Low
Days sales outstanding (365 days) 43.80 days 43.80 days 34.00 days 32.00 days OK
Inventory turnover 8.33x 8.33x 10.00x 11.00x Slightly Low
Fixed assets turnover 4.00 4.00 3.57 5.00 Low
Total assets turnover 2.00 2.00 2.00 2.50 Slightly Low
Debt/assets 30.00% 40.34% 40.34% 36.00% High
Times interest earned 6.25x 7.81x 7.81x 9.40x Low
Current ratio 2.50 1.99 1.75 3.00 Low