CHAPTER 5: FINANCIAL STATEMENT FORECASTING

Instructor’s Manual Problem Set

Solutions can be found in the accompanying Excel files. Note that if you wish to see all of the formulas at
once, you may use the CTRL+` (Control plus grave accent) shortcut key to toggle them on or off.

1. Fashion Trends, Inc., a regional fashion apparel retailer, wants to prepare a 2018 Pro Forma
Income Statement and a 2018 Balance Sheet using the following 2017 and 2016 data:
Fashion Trends, Inc. Fashion Trends, Inc.
Balance Sheet Balance Sheet
For the Period Ended Dec. 31, 2017 As of Dec. 31, 2017
2017 2016 Assets 2017 2016
Sales 6,148,000 5,134,000 Cash and Equivalents 862,000 678,000
Cost of Goods Sold 4,176,000 3,422,000 Accounts Receivable 1,006,000 730,000
Gross Profit 1,972,000 1,712,000 Inventory 578,000 600,000
S,G&A Expenses 588,000 590,000 Total Current Assets 2,446,000 2,008,000
Fixed Expenses 70,000 70,000 Plant & Equipment 9,338,000 8,644,000
Depreciation Expense 478,000 446,000 Accumulated Depreciation 4,590,000 4,112,000
EBIT 836,000 606,000 Net Fixed Assets 4,748,000 4,532,000
Interest Expense 186,000 182,000 Total Assets 7,194,000 6,540,000
Earnings Before Taxes 650,000 424,000 Liabilities and Owners' Equity
Taxes 195,000 127,200 Accounts Payable 764,000 540,000
Net Income 455,000 296,800 Short-term Notes Payable 158,000 198,000
Accrued Expenses 318,000 228,000
Total Current Liabilities 1,240,000 966,000
Long-term Debt 2,046,000 1,934,000
Total Liabilities 3,286,000 2,900,000
Common Stock 1,638,000 1,616,000
Retained Earnings 2,270,000 2,024,000
Total Shareholder's Equity 3,908,000 3,640,000
Total Liabilities and Owners' Equity 7,194,000 6,540,000

The firm has forecasted sales of $7,100,000 and a tax rate of 40% for 2018. Cost of goods sold
and S,G&A expense in 2018 are expected to be the average of their two-year proportion of
sales. On the balance sheet, accounts receivable, inventory, accounts payable, and accrued
expenses are expected to be at the two-year average of the proportion of these items in relation
to sales. The firm has planned an investment of $500,000 in fixed assets in 2018, with an
estimated life of 10 years and no salvage value. These fixed assets will be depreciated using the
straight line depreciation method. All other financial statement items are expected to remain
constant in 2018. Assume the firm pays 4% interest on short-term debt and 7% on long term
debt. Assume that the dividends in 2018 will be the same as those paid in 2017.
a) What is the Discretionary Financing Needed (DFN) in 2018? Is this a surplus or deficit?
b) DFN will be absorbed by long-term debt. Set up an iterative worksheet to eliminate it.
c) Turn off iteration, and use the Scenario Manager to set up three scenarios:
1. Best Case — Sales are 15% higher than expected.
2. Base Case — Sales are exactly as expected.
3. Worst Case — Sales are 15% less than expected.
What is the DFN under each scenario?

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32 Chapter 5: Financial Statement Forecasting
Instructor’s Manual Problem Set

2. NVIDIA Corp. financial statements are presented below. Analysts forecast that its 2018 sales
will be $8,260. The expected 2018 tax rate will be 17.35%. Assume the firm pays 5% interest on
short-term debt and 7% on long term debt.
NVIDIA Corporation
Income Statement ($ in Millions)
For the Years 2012 to 2017
Jan-17 Jan-16 Jan-15 Jan-14 Jan-13 Jan-12
Sales 6,910 5,010 4,682 4,130 4,280 3,998
Cost of Goods Sold 2,648 2,002 1,862 1,623 1,828 1,743
Gross Income 4,262 3,008 2,820 2,507 2,453 2,255
Research & Development 1,463 1,331 1,360 1,336 1,147 984
Other SG&A 641 532 443 436 431 398
Depreciation Expense 187 197 220 239 226 204
Other Operating Expense 2 0 0 0 0 0
EBIT (Operating Income) 1,969 948 796 496 648 669
Nonoperating Income - Net 50 43 42 24 17 7
Interest Expense 58 47 46 10 3 3
Unusual Expense - Net 56 201 37 0 0 9
Pretax Income 1,905 743 755 510 662 663
Income Taxes 239 129 124 70 100 82
Net Income 1,666 614 631 440 563 581

Dividends per Share 0.49 0.40 0.34 0.31 0.08 0.00

Shares Outstanding 649.00 569.00 563.07 594.52 624.96 616.37
Tax Rate 12.55% 17.36% 16.46% 13.77% 15.03% 12.41%

NVIDIA Corporation
Balance Sheet ($ in Millions)
For the Years 2012 to 2017
Jan-17 Jan-16 Jan-15 Jan-14 Jan-13 Jan-12
Assets
Cash 1,766 596 497 1,151 431 253
Short-Term Investments 5,032 4,441 4,127 3,521 3,297 2,876
Accounts Receivable 826 505 474 426 454 336
Inventories 794 418 483 388 420 340
Other Current Assets 118 93 133 139 173 99
Total Current Assets 8,536 6,053 5,713 5,625 4,775 3,905
Gross Plant & Equipment 1,191 1,100 1,179 1,283 1,289 1,157
Accumulated Depreciation 670 634 622 700 713 596
Net Plant & Equipment 521 466 557 583 576 560
Other Assets 784 851 931 1,043 1,061 1,087
Total Assets 9,841 7,370 7,201 7,251 6,412 5,553
Liabilities & Shareholders’ Equity
ST Debt & Current Portion LT Debt 800.0 1,413.0 0.0 2.9 0.0 0.0
Accounts Payable 485.0 296.0 293.2 324.4 356.4 335.1
Other Current Liabilities 503.0 642.0 602.8 621.1 619.8 594.9
Total Current Liabilities 1,788.0 2,351.0 896.0 948.4 976.2 930.0
Long-Term Debt 2,020 97 1,398 1,371 19 21
Other Liabilities 271 453 489 475 589 456
Total Liabilities 4,079 2,901 2,783 2,794 1,585 1,407
Common Equity 5,762 4,469 4,418 4,456 4,828 4,146
Total Liabilities & Shareholders’ Equity 9,841 7,370 7,201 7,251 6,412 5,553

a) Use your judgement to forecast the items on the income statement and balance sheet with the percent
of sales method. What is the discretionary financing needed in 2018? Is this a surplus or deficit?
Chapter 5: Financial Statement Forecasting 33
Instructor’s Manual Problem Set

Assume that the dividends per share will be $0.54 and the number of shares will be the same as in
2017.
b) Assume that DFN will be absorbed by long-term debt and that the interest rate is 2.5% of the sum of
LTD and short-term debt. Set up an iterative worksheet to eliminate it.
c) Create a scatter chart of research and development vs. sales and add a linear trend line. Does there
appear to be a consistent trend in this relationship?
d) Use the regression tool to verify your results from part c. Is the trend statistically significant? Use at
least three methods to show why or why not.
e) Turn off iteration, and use the Scenario Manager to set up three scenarios:
1. Best Case — Sales are 15% higher than expected.
2. Base Case — Sales are exactly as expected.
3. Worst Case — Sales are 15% less than expected.
What is the DFN under each scenario?

3. Use the same data as in the previous problem.

a) Recalculate the percentage of sales income statement, but this time use the Trend function to forecast
cost of goods sold, research and development, and Other S,G&A expenses.
b) Recalculate the percentage of sales balance sheet, but this time use the Trend function to forecast
cash, short-term investments, other current assets, gross plant and equipment, other assets, other long
term assets, short term debt and current portion of LT debt, and other current liabilities.
c) Repeat question e of the previous problem.

4. Use monthly total returns for the S&P 500 index, Xcel Energy (XEL), NVIDIA (NVDA), Bank
of America (BAC), and Tesco PLC (TSCO) from July 2012 through June 2017.
a) Create an XY (Scatter) plot to show the relationship between the returns on each individual stock and
the S&P 500. Estimate the slope of a regression equation of this data.
b) Add a linear trend line to each chart, and place the equation and R2 on each chart. How much of the
variability in each stock’s returns can be explained by variability in the S&P 500?
c) Repeat the previous two questions with an equally weighted portfolio that includes all of these stocks.
Use the arithmetic average of the monthly returns of each stock as the expected return in your
portfolio. Do you see any improvements in the R-square?

5. Using the Analysis ToolPak add-in, run two regression models using returns from Xcel Energy
and NVIDIA. Your dependent variable will be the Xcel Energy or NVIDIA monthly returns,
and the independent variable will be the S&P 500 returns. Compare the R2 from both
regressions.
34 Chapter 5: Financial Statement Forecasting
Instructor’s Manual Problem Set

CHAPTER 5: MULTIPLE CHOICE QUESTIONS

1. Consider the regression results where sales

is the independent variable and cash is the
dependent variable. If next year’s sales are
forecasted to be 8,260, what is the forecast
for cash?
a) $3,953.95
b) $4,054.37
c) $2,201.57
d) $1,221.30
e) $799.84
Solution: c

2. Consider the chart where sales is the

independent variable and cash is the
dependent variable. Using the equation for
the trend line, if next year’s sales are
forecast to be 8,260, what is the forecast for
cash?

a) $3,953.95
b) $4,054.37
c) $2,201.64
d) $1,221.30
e) $799.84
Solution: c

3. What would be the value of cell B3 if the formula is

{=AVERAGE(C3:D3/C2:D2)*B2}?

a) 3,233
b) 4,615
c) 4,253
d) 3,735
e) 2,678
Solution: a
Chapter 5: Financial Statement Forecasting 35
Instructor’s Manual Problem Set

4. What would be the value

of cell C1?
a) “Surplus”
b) “Deficit”
c) “Balanced”
Solution: b

5. What would be the value of cell B2?

a) 175
b) 200
c) 250
d) 225
e) 190
Solution: d

6. What would be the value of cell

B8? (Hint: look at the chart.)

a) 5,842.21
b) 6,565.08
c) 6,831.29
d) 6,978.91
e) 7,105.54
Solution: b
36 Chapter 5: Financial Statement Forecasting
Instructor’s Manual Problem Set

7. According to the regression output, what is

the proportion of the total variation in the
dependent variable that is explained by the
independent variable(s)?

a) 78.77%
b) 62.04%
c) 52.55%
d) 392.51%
Solution: b

8. Which of the following functions allows you to calculate one or more parameters of a
regression equation?
a) INTERCEPT
b) SLOPE
c) LINEST
d) All of the above
e) None of the above
Solution: d

9. Which of the following functions allows you to generate forecasts?

a) TREND
b) FORECAST
c) GROWTH
d) LOGEST
e) All of the above
Solution: e

10. According to the following output, which of

the results is statistically significant?
a) The intercept
b) Sales
c) Both the intercept and sales
d) Neither the intercept, nor sales
e) the p-value
Solution: b
Chapter 5: Financial Statement Forecasting 37
Instructor’s Manual Problem Set

11. In order to judge the significance of an entire model, as opposed to individual variables, you
must look at the:
a) R Square (R2)
b) adjusted R Square (R2)
c) F statistic
d) t-statistic
e) standard error.
Solution: c

12. If the discretionary financing needed (DFN) is negative, that represents a of

discretionary funding.
a) surplus
b) deficit
c) neither
d) both

Solution: a

13. A circular error results when a formula refers to:

a) a cell in another workbook that is closed.
b) the same cell that contains the formula.
c) another cell that refers back to the cell that contains the formula
d) a and b
e) b and c
Solution: e