CHAPTER 10

FORECASTING FINANCIAL STATEMENTS

Solutions to Questions, Exercises, Problems, and Teaching Notes to Cases

10.1 Relying on Accounting to Avoid Forecast Errors. This question encourages

students to think about the internal consistency in accounting and how it can help
avoid forecast errors. By forecasting financial statements that add up, the analyst is
less likely to miss a key account. By forecasting financials that articulate over time,
the analyst is more likely to capture all of the income flows (and cash inflows and
outflows) over the period.

10.2 Objective and Realistic Forecasts. In answering this question, students consider
why different parties to the financial reporting process have different incentives and
biases. Managers tend to be optimistic to present their firm and their own
performance in good light. Accountants are conservative, in part, to be a
counterweight to managers’ optimism and to mitigate their own professional risk
and liability. The analyst should be as objective as possible in forecasting the future
in order to make better investment decisions.

10.3 Projecting Revenues: The Effects of Volume versus Price. This question gets
students thinking about different drivers of different components of revenue growth
in a general setting. A firm’s competitive strategic advantages should help it sustain
revenue growth from sales volume growth and price growth. The nature of
competition in the firm’s industry and the position of the industry in its life-cycle
(introduction, growth, mature, or decline) will likely influence the firm’s ability to
sustain growth, particularly in more competitive and mature industries. Economy-
wide factors such as demographic growth may help sustain volume growth, whereas
economy-wide inflation may help sustain price growth. Although the question relies
on a one-year horizon, you could push the discussion further so that students
consider how the factors are likely to affect sales volume growth and price growth
in the long run.

10.4 Projecting Gross Profit: The Effects of Volume Versus Price. This question gets
students thinking about how drivers of different components of revenue growth
have different effects on gross profit and gross profit margin (as a percentage of
sales revenues) in a general setting. Both factors drive up gross profit. Only price
increases drive up the gross profit margin because the question assumes the strictly
variable production costs. Thus, cost of goods sold is a variable cost per unit, so
sales volume increases are accompanied by proportional increases in cost of goods
sold. However, price increases do not trigger cost increases.

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 Chapter 10
Forecasting Financial Statements

10.5 Projecting Revenues, Cost of Goods Sold, and Inventory. In this exercise,
students work through the computations to project revenue, cost of goods sold, and
ending inventory for Walgreens. The data and computations follow:

Walgreens’ (data in millions) Year 2014 Year 2015 Growth Rates Year +1
Sales Revenue............................ $76,392 $103,444 35.4% $140,076
Cost of Goods Sold ................... $54,823 $ 76,520 39.6% $106,804
Ending Inventory ...................... $ 6,076 $ 8,678

Year 2015 Inventory Turnover ................... $76,520/[($6,076 + $8,678)/2] = 10.37

Projected Average Inventory …………….. $106,804/10.37 = $10,299
Projected Ending Inventory …………….... ($10,299 × 2) – $8,678 = $11,920

10.6 The Flexible Financial Account. This question asks students to discuss how a
firm’s financial flexibility will change as the firm progresses through stages of the
life cycle. During the introduction phase, the firm needs capital but may be
somewhat constrained to issue debt, so it is more likely the firm will balance the
balance sheet by issuing equity. As equity issues raise cash, start-up firms
commonly hold the cash in liquid accounts until it is invested in growth-related
assets. During the growth phase, firms are more likely to meet their capital needs by
issuing debt or equity capital. During the mature and decline phases, the firm’s
capital needs are more likely to be met with cash flow from operations and the firm
should return capital to stakeholders, so the firm will likely balance the balance
sheet by paying dividends, buying back stock, or paying down debt.

10.7 Dividends as a Flexible Financial Account. This exercise asks students to

compute the plug to dividends to balance the balance sheet for Schwartz Company
for Year +1. Students can compute the plug to dividends as follows:

Year +1 Balance Sheet Amounts before Plugging Dividends:

Total Assets $200

Accrued Liabilities $ 43
Long-Term Debt 80
Common Stock (at par) 20
Beginning Retained Earnings 34
Year +1 Net Income 40
Total Liabilities and Equity
before Plugging Dividends $217

Necessary plug to increase dividends to balance the balance sheet: $17.

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 Chapter 10
Forecasting Financial Statements

Year +1 Balance Sheet Amounts after Plugging Dividends:

Total Assets $200

Accrued Liabilities $ 43
Long-Term Debt 80
Common Stock (at par) 20
Ending Retained Earnings 57 = $34 + $40 – $17
Total Liabilities and Equity $200

10.8 Long-Term Debt as a Flexible Financial Account. This exercise asks students to
compute the plug to long-term debt to balance the balance sheet for Schwartz
Company for Year +1. This exercise introduces circularity to balancing the balance
sheet because the amount of debt needed depends on net income, which is affected
by the interest expense on the amount of debt needed. Students should input these
amounts into a spreadsheet and have the spreadsheet compute the amounts
iteratively. Students should obtain the following amounts:

Year +1
Projected Income Statement Amounts
Operating Income............................... $58.00
Interest Expense ................................. (8.87)
Income before Tax ............................. $49.13
Tax Provision (20.0% rate) ................ (9.83)
Net Income ......................................... $39.30

Year +1
Projected Balance Sheet Amounts
Total Assets ........................................ $200

Accrued Liabilities ............................. $ 43

Long-Term Debt ................................ 88.70
Common Stock (at par) ...................... 20
Retained Earnings (end of Year +1) .. 48.30 = $34.00 + $39.30 – $25.00
Total Liabilities and Shareholders’ Equity $200

10.9 Store-Driven Forecasts. In this exercise, students work through the computations
to project revenue, capital expenditures, and ending inventory for The Home Depot,
using 10 new stores as the driver of growth forecasts in Year +1. The exercise
requires students to use the average number of stores to compute sales, the number
of new stores to compute capital expenditures, and the ending number of total stores
to compute ending inventory. The data and computations follow:

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 Chapter 10
Forecasting Financial Statements

The Home Depot (data in mil-

lions except number of stores) 2014 2015 Year +1 Computations
Number of Stores ................... 2,269 2,274 2,284
New Stores ............................. 5 10
Average Stores ....................... 2,272 2,277

Sales Revenues....................... $83,176 $88,519 $88,712 = 2,277 × $5.20

Sales per Average Store ......... $38.96 = $88,519/2,272

Inventory ................................ $11,079 $11,809 $11,840 = 2,277 × $5.20

Ending Inventory per Store .... $4.69 = $11,809/2,274

Capital Expenditures (Net) .... $1,442 $1,503 $3,006 = 10 × $300.60

Capital Expenditures per
New Store .......................... $300.60 = $1,503/5

10.10 Projecting Property, Plant, and Equipment. This exercise gets students working
through the computations to project property, plant, and equipment and depreciation
expense for Year +1 for Intel, a leading manufacturer of semiconductors.

a. The average useful life that Intel used in 2015 for depreciation was 10.43 years,
computed as follows:

Useful Life ..................... 10.43 Years = [($79,709 + $83,396)/2]/$7,821

b. Depreciation expense for Year +1 on (1) existing property, plant, and equipment
at the end of 2015; (2) capital expenditures in Year +1 assuming that there is
$6,000 in expenditures on depreciable assets in Year +1 and assuming that Intel
takes a full year of depreciation in the first year of service; and (3) the sum of
(1) and (2) to obtain total depreciation expense for Year +1:

Depreciation Expense on Existing PPE ...... $ 7,996 = $83,396/10.43 years

Depreciation Expense on Year +1 Capital
Expenditures ............................................ $ 575 = $6,000/10.43 years
Total Depreciation Expense ........................ $ 8,571 = $7,996 + $575

c. The Year +1 ending balance in property, plant, and equipment, both at cost and
net of accumulated depreciation:
Intel (data in millions) 2014 2015 Year +1 Computations
Property, Plant, and Equip., at Cost .. $79,709 $83,396 $89,396 = $83,396 + $6,000
Accumulated Depreciation ............... ($46,471) ($51,538) ($60,109) = ($51,538) – $8,571
Property, Plant, and Equip. (Net) ..... $33,238 $31,858 $29,287 = $89,396 – $60,109
Depreciation Expense ....................... $ 7,821 $ 8,571 Computed above
Capital Expenditures (Net) ............... $ 5,326 $ 6,000 Assumption given

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 Chapter 10
Forecasting Financial Statements

10.11 Identifying the Cost Structure and Projecting Gross Margins for Capital-
Intensive, Cyclical Businesses.
a. Compute the cost structure for each firm as follows:
Variable Cost per Dollar of Sales = Change in Cost of Products Sold/Change in
Sales
Total Variable Cost = Variable Cost per Dollar of Sales × Sales
Total Fixed Cost = Total Cost of Product Sold – Total Variable Cost
AK Steel:
Variable Cost per Dollar of Sales = ($4,554 – $3,887)/($5,217 – $4,042) = $0.568
Total Variable Cost = $0.568 × $5,217 = $2,963 (65% of cost of products sold)
Total Fixed Cost = $4,554 – $2,963 = $1,591 (35% of cost of products sold)
Nucor:
Variable Cost per Dollar of Sales = ($9,129 – $5,997)/($11,377 – $6,266) = $0.613
Total Variable Cost = $0.613 × $11,377 = $6,974 (76% of cost of products sold)
Total Fixed Cost = $9,129 – $6,974 = $2,155 (24% of cost of products sold)

b. AK Steel is more capital-intensive than Nucor and therefore has a higher

proportion of fixed costs and a lower proportion of variable costs in its cost
structure. AK Steel also offers steel and steel products at the higher end of the
market than Nucor does and should, therefore, have higher selling prices and a
higher gross margin. Both of these factors explain the lower variable cost as a
percentage of sales for AK Steel.

c. (amounts in millions)
AK Steel
Year +1 Year +2 Year +3 Year +4 Year +5
Sales $5,478 $6,026 $7,231 $6,508 $5,206
Less Cost of Products Sold:
Variable Costs (0.568 of sales) 3,112 3,423 4,107 3,697 2,957
Fixed Costs 1,591 1,591 1,591 1,591 1,591
Total Costs of Products Sold $4,703 $5,014 $5,698 $5,288 $4,548
Gross Profit $775 $1,012 $1,533 $1,220 $658
Gross Margin % 14.1% 16.8% 21.2% 18.7% 12.6%

Nucor
Year +1 Year +2 Year +3 Year +4 Year +5
Sales $11,946 $13,140 $15,768 $14,191 $11,353
Less Cost of Products Sold:
Variable Costs (0.613 of sales) 7,323 8,055 9,666 8,699 6,959
Fixed Costs 2,155 2,155 2,155 2,155 2,155
Total Costs of Products Sold $9,478 $10,210 $11,821 $10,854 $9,114
Gross Profit $2,467 $2,931 $3,947 $3,337 $2,239
Gross Margin % 20.7% 22.3% 25.0% 23.5% 19.7%

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 Chapter 10
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d. The average gross margin of AK Steel is 16.7%, with a standard deviation of

3.5%. The average gross margin of Nucor is 22.2%, with a standard deviation of
2.1%. Despite a higher variable cost per dollar of sales and larger total fixed
costs, Nucor generates a higher gross margin than AK Steel because Nucor’s
much larger size creates economies of scale. For example, Nucor’s fixed costs
are 24% of cost of products sold compared to AK Steel’s fixed costs, which
amount to 35% of the cost of products sold. The larger variability of the gross
margin for AK Steel also occurs because of the higher proportion of fixed costs
in its cost structure. Compared with Nucor, AK Steel realizes greater
incremental economies of scale as sales increase but greater diseconomies of
scale as sales decrease. For example, given the same rates of sales growth over
Years +1 to +3, AK Steel’s gross margin grows from 14.1% to 21.2%, whereas
Nucor’s gross margin percentage grows from only 20.7% to 25.0%.

10.12 Identifying the Cost Structure (amounts in billions).

a. Change in Cost of Goods Sold: (¥5,275 – ¥5,140) ........................ ¥135
Change in Sales: (¥7,036 – ¥6,682) .............................................. ¥354
Variable Cost Percentage: ¥135/¥354 ............................................ 0.381
Fixed Cost: 2014, [¥5,140 – (0.381 × ¥6,682)] ............................. ¥2,594
2015, [¥5,275 – (0.381 × ¥7,036)] ............................. ¥2,594

b. Change in Selling and Administrative Expense: (¥1,811 – ¥1,729) ¥82

Change in Sales: from Requirement a ........................................... ¥354
Variable Cost Percentage: ¥82/¥354 .............................................. 0.232
Fixed Cost: 2014, [¥1,729 – (0.232 × ¥6,682)] ............................. ¥179
Fixed Cost: 2015, [¥1,811 – (0.232 × ¥7,036)] ............................. ¥179

c. and d. Year +1 Year +2 Year +3 Year +4

Sales ............................................. ¥7,880 ¥8,668 ¥9,361 ¥9,923
Cost of Goods Sold:
Fixed ........................................ (2,594) (2,594) (2,594) (2,494)
Variable (0.381 of Sales) ......... (3,002) (3,303) (3,567) (3,781)
Selling and Administrative Expense:
Fixed ........................................ (179) (179) (179) (179)
(0.232 of Sales)........................ (1,828) (2,011) (2,172) (2,302)
Operating Income before Income
Taxes ....................................... ¥277 ¥581 ¥849 ¥1,167
Operating Income before Income
Taxes/Sales .............................. 3.5% 6.7% 9.1% 11.8%

e. The percentage of operating income before income taxes to sales increases over
time because Sony Corporation spreads its fixed operating costs over a larger
sales volume. These increasing percentages do not portray a full picture of the
changes in the firm’s profitability. Although sales are projected to increase, they
increase at a continually decreasing rate. It is likely that Sony Corporation would
adjust its selling prices, manufacturing costs, or selling and administrative costs in

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 Chapter 10
Forecasting Financial Statements

response to the projected declining rate of growth in sales. Such adjustments

would change the cost structure computed in Requirements a and b above.

10.13 Smoothing Changes in Accounts Receivable (amounts in millions).

a. Hasbro accounts receivable turnover: $4,448/[0.5($1,218 + $1,095)] = 3.85.

b.
Percentage
Accounts Average Ending Accounts Receivable Change in
Receivable Accounts Beginning End of Accounts
Sales Turnover Receivable of Year Year Receivable
Year +1 $5,026 3.85 $1,306 $1,218 $1,393 +14.4%
Year +2 $5,680 3.85 $1,475 $1,393 $1,557 +11.8%
Year +3 $6,418 3.85 $1,667 $1,557 $1,777 +14.1%
Year +4 $7,252 3.85 $1,885 $1,777 $1,991 +12.1%
Year +5 $8,195 3.85 $2,129 $1,991 $2,266 +13.8%

c. The changes in receivables exhibit the sawtooth pattern described in the chapter.
Such a pattern does not seem reasonable in light of the assumptions of smooth
growth in sales and steady accounts receivable turnover. The cause of the
sawtooth pattern is the slightly lower than average balance in receivables during
2015, which causes the change in receivables in Year +1 to be unusually large
to compensate; the same holds true for Year +2, Year +3, and Year +4, and so
on.

d. The increase in accounts receivable from $1,218 million at the end of 2015 to
$2,266 million at the end of Year +5 represents a compound annual rate of
growth of 13.22% over those five years. Using this rate of growth to project a
smooth pattern of receivables growth leads to the following projections:
Ending Accounts Receivable
Year +1 $1,218 × 1.1322 = $1,379
Year +2 $1,379 × 1.1322 = $1,561
Year +3 $1,561 × 1.1322 = $1,768
Year +4 $1,768 × 1.1322 = $2,001
Year +5 $2,001 × 1.1322 = $2,266

e. An increase in accounts receivable from $1,218 million to $1,991 million over

four years represents a compound annual rate of growth of 13.07%.
Ending Accounts Receivable
Year +1 $1,218 × 1.1307 = $1,377
Year +2 $1,377 × 1.1307 = $1,557
Year +3 $1,557 × 1.1307 = $1,761
Year +4 $1,761 × 1.1307 = $1,991
Year +5 $1,991 × 1.1307 = $2,251

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 Chapter 10
Forecasting Financial Statements

The difference in growth rate in Requirements d and e results from using an

ending accounts receivable date that is an upward “sawtooth” (Requirement c)
and a downward “sawtooth” (Requirement d). Observe from Requirement b that
accounts receivable increased 12.1% during Year +4 (a down “sawtooth”) but
increased 13.8% during Year +5 (an up “sawtooth”).

f. Turnover based on year-end accounts receivable balance: $4,448/$1,218 = 3.65

Accounts Accounts Receivable Change in

Receivable Beginning End of Accounts
Sales Turnover of Year Year Receivable
Year +1 $5,026 3.65 $1,218 $1,536 26.1%
Year +2 $5,680 3.65 $1,376 $1,576 2.6%
Year +3 $6,418 3.65 $1,555 $1,941 23.1%
Year +4 $7,252 3.65 $1,985 $2,033 4.8%
Year +5 $8,195 3.65 $2,244 $2,457 20.9%

10.14 Smoothing Changes in Inventories (amounts in thousands).

a. Barnes & Noble inventory turnover: $4,197/[0.5($1,235 + $1,293)] = 3.32

b. Cost of Inventories Percentage

Goods Inventory Average Beginning End of Change in
Sold Turnover Inventories of Year Year Inventories
Year +1 $4,684 3.32 $1,411 $1,293 $1,529 +18.2%
Year +2 $5,227 3.32 $1,575 $1,529 $1,620 +6.0%
Year +3 $5,834 3.32 $1,757 $1,620 $1,894 +16.9%
Year +4 $6,510 3.32 $1,961 $1,894 $2,028 +7.1%
Year +5 $7,265 3.32 $2,188 $2,028 $2,349 +15.8%

These projections exhibit substantial volatility in ending inventory, which is

unrealistic considering the assumptions of smooth growth in sales and costs of
sales.

c. The above projections indicate an increase in inventories from $1,293 to $2,349

over five years, representing a compound annual rate of growth of 12.68%
[($2,349/$1,293)^(1/5) –1].

Ending Inventories
Year +1 $1,293 × 1.1268 = $1,457
Year +2 $1,457 × 1.1268 = $1,642
Year +3 $1,642 × 1.1268 = $1,850
Year +4 $1,850 × 1.1268 = $2,085
Year +5 $2,085 × 1.1268 = $2,349

These smoothed inventory forecasts more closely match the assumptions of

smooth growth in sales and costs of goods sold.

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 Chapter 10
Forecasting Financial Statements

d. Barnes & Noble inventories actually increased from $1,235 at the end of 2014
to $1,293 at the end of 2015, an increase of 4.7%. Using this growth rate leads
to the following projections of inventories and implied turnover rates:

Ending Inventories Implied Turnover

Year +1 $1,293 × 1.047 = $1,354 $4,684/[($1,293 + $1,354)/2] = 3.54
Year +2 $1,354 × 1.047 = $1,417 $5,227/[($1,354 + $1,417)/2] = 3.77
Year +3 $1,417 × 1.047 = $1,484 $5,834/[($1,417 + $1,484)/2] = 4.02
Year +4 $1,484 × 1.047 = $1,554 $6,510/[($1,484 + $1,554)/2] = 4.29
Year +5 $1,554 × 1.047 = $1,627 $7,265/[($1,554 + $1,627)/2] = 4.57

This exercise demonstrates that simply assuming that past growth rates will
persist can lead to unreasonable forecasts. In this case, it is highly unlikely that
Barnes & Noble can continue to increase inventory at a rate of only 4.7% per
year while at the same time generating sales growth of 11.6% per year. It would
be very unusual for a retail bookstore such as Barnes & Noble to be able to
achieve 4.57 inventory turns a year by Year +5.

10.15 Identifying Financial Statement Relations.

a. Retained Earnings, Beginning of Year +1 ...................................... $ 21,700
Net Income for Year +1 .................................................................. 1,153
Retained Earnings, End of Year +1 ................................................ (22,043)
Dividend Declared and Paid for Year +1........................................ $ 810

b. Accumulated Depreciation, End of Year +1 ................................... $ 36,112

Accumulated Depreciation, End of Year 0 ..................................... (33,100)
Depreciation Expense for Year +1.................................................. $ 3,012

c. Inventories, End of Year +1 ............................................................ $ 8,223

Increase in Inventories for Year +2 ................................................ 1,322
Inventories, End of Year +2 ............................................................ $ 9,545

d. Average Notes Payable for Year +2: 0.5($6,852 + $7,195) ........ $ 7,023.50
Average Long-Term Debt for Year +2: 0.5($49,094 + $51,549) 50,321.50
Average Interest-Bearing Liabilities for Year +2 ........................ $ 57,345.00
Interest Rate ................................................................................. × 0.07
Interest Expense for Year +2 ....................................................... $ 4,014.15

e. Other Current Liabilities, End of Year +1 ...................................... $ 3,630

Increase in Other Current Liabilities for Year +2 ........................... 436
Other Current Liabilities, End of Year +2 ...................................... $ 4,066

f. Fixed Assets, End of Year +2 ......................................................... $126,467

Acquisitions of Fixed Assets during Year +3 ................................. 24,796
Fixed Assets, End of Year +3 ......................................................... $151,263

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Chapter 10
Forecasting Financial Statements

g. Retained Earnings, End of Year +2 ................................................ $ 23,700

Net Income for Year +3 .................................................................. 4,206
Dividends Declared and Paid during Year +3 ................................ (1,016)
Retained Earnings, End of Year +3 ................................................ $ 26,890

h. Long-Term Debt, End of Year +2 .................................................. $ 51,549

Increase in Long-Term Debt during Year +2 ................................. 10,107
Long-Term Debt, End of Year +3 .................................................. $ 61,656

i. Income Tax Expense for Year +4 ................................................... $ 2,892

Net Income before Income Taxes for Year +4: $5,370 + $2,892 ... 8,262
Income Tax Rate: $2,892/$8,262 .................................................... 35%

j. Cost of Goods Sold for Year +4 ..................................................... $ 46,465

Inventories, End of Year +4 ............................................................ 11,333
Inventories, End of Year +3 ............................................................ (10,711)
Purchase of Inventories during Year +3 ......................................... $ 47,087

Integrative Case 10.1: Walmart

This case provides students with an extensive integrated exercise in building financial
statement forecast models. The case allows students to focus on building the models
(computing forecast amounts, determining projected net income, and balancing balance
sheets and cash flow statements) rather than developing the forecast assumptions, which
the case provides. In addition, the case requires students to consider the use of different
financial flexible accounts to balance the balance sheet (cash versus dividends) and the
implications of each. The case is based on Walmart data through 2015 and requires
students to build forecasts through Year +5. For continuity, you can use this case in
conjunction with Chapter 4’s problems involving ratio computations and analyses as well
as problems dealing with valuation in Chapters 11 through 14. To provide a structured
approach in evaluating the underlying assumptions in financial statement forecasts, you
can also use this case to lead students to debate and challenge the forecast assumptions
given in the problem. An FSAP template is available for this problem on the textbook
website. Go to the instructor’s resources page at www.cengage.com/accounting/wahlen.

a. The financial statement forecasts and financial ratios for Walmart for Year +1 to Year
+5 appear in Exhibits 10.A–10.C.

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 Exhibit 10.A
©
© 2018
2018 Cengage

Walmart Stores—Income Statement Forecasts (amounts in millions)

(Integrative Case 10.1)
Cengage Learning

Actuals Forecasts
Learning®®.. May

Year 2013 2014 2015 Year +1 Year +2 Year +3 Year +4 Year +5 Year +6
INCOME STATEMENT
Revenues 476,294 485,651 482,130 491,773 501,608 511,640 521,873 532,310 548,280
May not

common size 100.0% 100.0% 100.0% 2.0% 2.0% 2.0% 2.0% 2.0%
rate of change (0.7%) Assume steady 2.0% revenue growth.
not be

2.0%
Cost of goods sold
be scanned,

(358,069) (365,086) (360,984) (368,829) (376,206) (383,730) (391,405) (399,233) (411,210)

scanned, copied

common size (75.2%) (75.2%) (74.9%) (75.0%) (75.0%) (75.0%) (75.0%) (75.0%) (75.1%)
rate of change 2.0% (1.1%) Assume steady cost of goods sold as a percent of sales.
Gross Profit 118,225 120,565 121,146 122,943 125,402 127,910 130,468 133,078 137,070
copied or

common size 24.8% 24.8% 25.1% 25.0% 25.0% 25.0% 25.0% 25.0% 25.0%
rate of change 2.0% 0.5% 1.5% 2.0% 2.0% 2.0% 2.0%
or duplicated,
duplicated, or
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Selling, general and administrative

(91,353) (93,418) (97,041) (98,355) (100,322) (102,328) (104,375) (106,462) (109,656)
expenses
common size (19.2%) (19.2%) (20.1%) (20.0%) (20.0%) (20.0%) (20.0%) (20.0%)
or posted
posted to

rate of change 2.3% 3.9% Assume steady SG&A expense as a percent of sales.
Operating Profit 26,872 27,147 24,105 24,589 25,080 25,582 26,094 26,616 27,414
to aa publicly

common size 5.6% 5.6% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0%
publicly accessible

rate of change 1.0% (11.2%) 2.0% 2.0% 2.0% 2.0% 2.0%

Forecasting
Forecasting Financial
Interest income 119 113 81 168 254 358 474 601 619
accessible website,

common size 0.0% 0.0% 0.0% 1.5% 1.5% 1.5% 1.5% 1.5%
rate of change (5.0%) (28.3%) Assume 1.5% interest earned on average balance in cash.
Interest expense
website, in

(2,335) (2,461) (2,548) (2,539) (2,615) (2,694) (2,775) (2,858) (2,944)

Financial Statements
common size (0.5%) (0.5%) (0.5%) (5.0%) (5.0%) (5.0%) (5.0%) (5.0%)
rate of change 5.4% 3.5% Weighted average interest rate on financial liabilities.
in whole

Income before Tax

whole or

24,656 24,799 21,638 22,217 22,719 23,246 23,793 24,358 25,089

Chapter
common size 5.2% 5.1% 4.5% 4.5% 4.5% 4.5% 4.6% 4.6% 4.6%

Chapter10
Statements
or in

rate of change 0.6% (12.7%) 2.7% 2.3% 2.3% 2.3% 2.4%

in part.
part.

10
 Income tax expense

Forecasting Financial Statements

Chapter 10
(8,105) (7,985) (6,558) (7,110) (7,270) (7,439) (7,614) (7,795) (8,028)
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

common size (1.7%) (1.6%) (1.4%) (32.0%) (32.0%) (32.0%) (32.0%) (32.0%)
rate of change (1.5%) (17.9%) Assume effective income tax rate equal to that of past two years.
Income (Loss) from discontinued
144 285 0 0 0 0 0 0 0
operations
common size 0.0% 0.1% 0.0% 0.0 0.0 0.0 0.0 0.0
rate of change 97.9% (100.0%) Assume no additional discontinued operations
Net Income 16,695 17,099 15,080 15,108 15,449 15,808 16,179 16,564 17,060
common size 3.5% 3.5% 3.1% 3.1% 3.1% 3.1% 3.1% 3.1% 3.1%
rate of change 2.4% (11.8%) 0.2% 2.3% 2.3% 2.3% 2.4% 3.0%
Net income attributable to noncontrolling
(673) (736) (386) (386) (386) (386) (386) (386) (398)
interests
common size (0.1%) (0.2%) (0.1%) 12.6% 12.6% 12.6% 12.6% 12.6%
rate of change 9.4% (47.6%) Assume noncontrolling interests earn a 12.6% rate of return.
Net income attributable to common
16,022 16,363 14,694 14,722 15,063 15,421 15,793 16,177 16,663
shareholders
common size 3.4% 3.4% 3.0% 3.0% 3.0% 3.0% 3.0% 3.0% 3.0%
rate of change 2.1% (10.2%) 0.2% 2.3% 2.4% 2.4% 2.4% 3.0%
10-12

Other comprehensive income items (2,409) (4,172) (4,429) 0 0 0 0 0 0

common size (0.5%) (0.9%) (0.9%) 0.0 0.0 0.0 0.0 0.0
rate of change (387.2%) (140.0%) Assume random walk with mean zero.
Comprehensive Income 14,286 12,927 10,651 14,722 15,063 15,421 15,793 16,177 16,663
common size 3.0% 2.7% 2.2% 3.0% 3.0% 3.0% 3.0% 3.0% 3.0%
rate of change (9.5%) (17.6%) 38.2% 2.3% 2.4% 2.4% 2.4% 3.0%
 Exhibit 10.B
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Walmart Stores—Balance Sheet Forecasts (including CAPEX and PP&E) (Integrative Case 10.1) (amounts in millions)
Actuals Forecasts
2013 2014 2015 Year +1 Year +2 Year +3 Year +4 Year +5 Year +5
BALANCE SHEET
ASSETS:
Cash and cash equivalents 7,281 9,135 8,705 13,675 20,225 27,539 35,614 44,459 46,141
common size 3.6% 4.5% 4.4% Plug Plug Plug Plug Plug
rate of change 25.5% (4.7%) Assume cash is the financial flexible account.
Accounts and notes receivable—net 6,677 6,778 5,624 5,736 5,851 5,968 6,088 6,209 6,396
common size 3.3% 3.3% 2.8% 2.0% 5.0% 5.0% 5.0% 5.0%
rate of change 1.5% (17.0%) Assume accounts receivable grow at the same rate as sales.
Inventories 44,858 45,141 44,469 45,472 46,382 47,309 48,255 49,220 50,697
common size 21.9% 22.2% 22.3% 45.0 45.0 45.0 45.0 45.0
rate of change 0.6% (1.5%) Assume ending inventory amounts to 45 days COGS.
Prepaid expenses and other current assets 1,909 2,224 1,441 1,470 1,499 1,529 1,560 1,591 1,639
common size 0.9% 1.1% 0.7% 2.0% 2.0% 2.0% 2.0% 2.0%
rate of change 16.5% (35.2%) Assume growth with SG&A expenses, which grow with sales.
10-13

Current assets of discontinued segments 460 0 0 0 0 0 0 0 0

common size 0.2% 0.0% 0.0% 0% 0% 0% 0% 0%
rate of change (100.0%) Assume no additional discontinued operations.
Current Assets 61,185 63,278 60,239 66,353 73,957 82,345 91,517 101,480 104,873
common size 29.9% 31.1% 30.2% 32.2% 34.6% 37.1% 39.8% 42.5% 42.6%
rate of change 3.4% (4.8%) 10.2% 11.5% 11.3% 11.1% 10.9% 3.3%
Property, plant, and equipment—at cost 178,678 182,634 188,054 198,054 208,054 218,054 228,054 238,054 245,196
common size 87.3% 89.8% 94.2%

Forecasting Financial Statements

rate of change 2.2% 3.0% PP&E assumptions—see schedule in forecast development
Accumulated depreciation (60,771) (65,979) (71,538) (81,441) (91,843) (102,746) (114,149) (126,052) (129,833)
common size (29.7%) (32.4%) (35.8%)
rate of change 8.6% 8.4% See depreciation schedule in forecast development worksheet.
Goodwill 19,510 18,102 16,695 17,029 17,369 17,717 18,071 18,433 18,986
common size 9.5% 8.9% 8.4% 2.0% 2.0% 2.0% 2.0% 2.0%
rate of change (7.2%) (7.8%) Assume growth with sales.
Other assets 6,149 5,455 6,131 6,254 6,379 6,506 6,636 6,769 6,972
common size 3.0% 2.7% 3.1% 2.0% 2.0% 2.0% 2.0% 2.0%
rate of change (11.3%) 12.4% Assume growth with sales.

Chapter 10
Total Assets 204,751 203,490 199,581 206,249 213,916 221,876 230,129 238,684 246,193
common size 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
rate of change (0.6%) (1.9%) 3.3% 3.7% 3.7% 3.7% 3.7% 3.1%
 Forecasting Financial Statements
Chapter 10
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Actuals Forecasts
2010 2011 2012 Year +1 Year +2 Year +3 Year +4 Year +5 Year +6
LIABILITIES:
Accounts payable 37,415 38,410 38,487 38,503 39,261 40,047 40,847 41,664 42,914
common size 18.3% 18.9% 19.3% 38.0 38.0 38.0 38.0 38.0
rate of change 2.7% 0.2% Assume a 38-day payment period consistent with prior years.
Current accrued expenses 18,793 19,152 19,607 19,999 20,399 20,807 21,223 21,648 22,297
common size 9.2% 9.4% 9.8% 2.0% 2.0% 2.0% 2.0% 2.0%
rate of change 1.9% 2.4% Assume growth with SG&A expenses, which grow with sales.
Notes payable and short-term debt 7,670 1,592 2,708 2,789 2,873 2,959 3,048 3,139 3,233
common size 3.7% 0.8% 1.4% 3.0% 3.0% 3.0% 3.0% 3.0%
rate of change (79.2%) 70.1% Assume 3% growth, consistent with rate of growth in total assets.
Current maturities of long-term debt 4,412 5,078 3,296 3,395 3,497 3,602 3,710 3,821 3,936
common size 2.2% 2.5% 1.7% 3.0% 3.0% 3.0% 3.0% 3.0%
rate of change 15.1% (35.1%) Assume 3% growth, consistent with rate of growth in total assets.
Income taxes payable 966 1,021 521 531 542 553 564 575 592
common size 0.5% 0.5% 0.3% 2.0% 2.0% 2.0% 2.0% 2.0%
rate of change 5.7% (49.0%) Assume 2% growth per year.
10-14

Current liabilities of discontinued operations 89 0 0 0 0 0 0 0 0

common size 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%
rate of change (100.0%) Assume no additional discontinued operations.
Current Liabilities 69,345 65,253 64,619 65,218 66,572 67,967 69,392 70,848 72,973
common size 33.9% 32.1% 32.4% 31.6% 31.1% 30.6% 30.2% 29.7% 29.6%
rate of change (5.9%) (1.0%) 0.9% 2.1% 2.1% 2.1% 2.1% 3.0%
Long-term debt obligations 44,559 43,495 44,030 45,351 46,711 48,113 49,556 51,043 52,574
common size 21.8% 21.4% 22.1% 3.0% 3.0% 3.0% 3.0% 3.0%
rate of change (2.4%) 1.2% Assume 3% growth, consistent with rate of growth in total assets.
Deferred tax liabilities—noncurrent 8,017 8,805 7,321 7,467 7,617 7,769 7,924 8,083 8,325
common size 3.9% 4.3% 3.7% 2.0% 2.0% 2.0% 2.0% 2.0%
rate of change 9.8% (16.9%) Assume 2% growth per year.
Redeemable noncontrolling interest 1,491 0 0 0 0 0 0 0 0
common size 0.7% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%
rate of change (100.0%) Assume remains zero.
Total Liabilities 123,412 117,553 115,970 118,036 120,900 123,849 126,873 129,973 133,873
common size 60.3% 57.8% 58.1% 57.2% 56.5% 55.8% 55.1% 54.5% 54.4%
rate of change (4.7%) (1.3%) 1.8% 2.4% 2.4% 2.4% 2.4% 3.0%
 SHAREHOLDERS’ EQUITY
Common stock + Additional paid in capital 2,685 2,785 2,122 2,186 2,251 2,319 2,388 2,460 2,534
common size 1.3% 1.4% 1.1% 3.0% 3.0% 3.0% 3.0% 3.0%
rate of change 3.7% (23.8%) Assume 3% growth, consistent with rate of growth in total assets.
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Retained earnings 76,566 85,777 90,021 94,559 99,296 104,240 109,400 114,783 118,227
common size 37.4% 42.2% 45.1%
rate of change 12.0% 4.9% Add net income and subtract dividends and share repurchases; see forecast box below.
Accum. other comprehensive income (loss) (2,996) (7,168) (11,597) (11,597) (11,597) (11,597) (11,597) (11,597) (11,597)
common size (1.5%) (3.5%) (5.8%) 0.0 0.0 0.0 0.0 0.0
rate of change 139.3% 61.8% Add accumulated other comprehensive income items from income statement
Total Common Shareholders’ Equity 76,255 81,394 80,546 85,148 89,950 94,962 100,192 105,646 109,163
common size 37.2% 40.0% 40.4% 41.3% 42.0% 42.8% 43.5% 44.3%
rate of change 6.7% (1.0%) 5.7% 5.6% 5.6% 5.5% 5.4%
Noncontrolling interests 5,084 4,543 3,065 3,065 3,065 3,065 3,065 3,065 3,157
common size 2.5% 2.2% 1.5% 0.0 0.0 0.0 0.0 0.0
rate of change (10.6%) (32.5%) Assume earnings attributable to noncontrolling interests paid in dividends.
Total Equity 81,339 85,937 83,611 88,213 93,015 98,027 103,257 108,711 112,320
common size 39.7% 42.2% 41.9% 42.8% 43.5% 44.2% 44.9% 45.5%
rate of change 5.7% (2.7%) 5.5% 5.4% 5.4% 5.3% 5.3%
Total Liabilities and Equities 204,751 203,490 199,581 206,249 213,916 221,876 230,129 238,684 246,193
common size 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
rate of change (0.6%) (1.9%) 3.3% 3.7% 3.7% 3.7% 3.7% 3.1%
Check figures: Balance Sheet A=L+OE? 0 0 0 0 0 0 0 0 0
10-15

Initial adjustment needed to balance the balance sheet:

(13,675) (20,225) (27,539) (35,614) (44,459) (46,141)

Dividends and share repurchases forecasts:

Common dividends: (6,183) (6,326) (6,477) (6,633) (6,794) (9,099)
(42.0%) (42.0%) (42.0%) (42.0%) (42.0%)
Assume dividend payout of net income.
Share repurchases (4,000) (4,000) (4,000) (4,000) (4,000) (4,120)

Forecasting Financial Statements

(4,000) (4,000) (4,000) (4,000) (4,000)
Assume $4,000 in share repurchases per year.
Total dividends: (10,183) (10,326) (10,477) (10,633) (10,794) (13,219)
Total dividends and share repurchases forecast amounts.

Flexible Financial Account: Additional Dividends:

Original Forecast Amounts:
Additional Dividends 0 0 0 0 0 0
Initial assumption—zero additional dividends.

Chapter 10
Implied adjustments: 0 0 0 0 0 0
Adjustment needed to balance the balance sheet, from above.
Total dividends: 0 0 0 0 0 0
Additional dividend payments.
 Forecasting Financial Statements
Chapter 10
Forecast Development: Capital Expenditures, Property, Plant, and Equipment, and Depreciation
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Capital Expenditures: CAPEX Forecasts:

2013 2014 2015 Year +1 Year +2 Year +3 Year +4 Year +5
CAPEX:
PP&E Acquired 13,115 12,174 11,477
PP&E Sold (727) (570) -635
Net CAPEX 12,388 11,604 10,842 10,000 10,000 10,000 10,000 10,000
Net CAPEX as a percent of:
Gross PP&E 7.2% 6.5% 5.9% 5.3% 5.0% 4.8% 4.6% 4.4%
Revenues 2.6% 2.4% 2.2% 2.0% 2.0% 2.0% 1.9% 1.9%
2.4%
Property, Plant, and Equipment and Depreciation Property, Plant, and Equipment and Depreciation Forecasts:
PP&E at cost: 2013 2014 2015 Year +1 Year +2 Year +3 Year +4 Year +5
Beg. balance at cost: 188,054 198,054 208,054 218,054 228,054
Add: CAPEX forecasts from above: 10,000 10,000 10,000 10,000 10,000
End balance at cost: 154,489 160,938 171,724 198,054 208,054 218,054 228,054 238,054
Accumulated Depreciation:
Beg. Balance: (71,538) (81,441) (91,843) (102,746) (114,149)
Subtract: Depreciation expense forecasts from below: (9,211) (9,836) (9,903) (10,403) (10,903)
10-16

End Balance: (60,771) (65,979) (71,538) (81,441) (91,843) (102,746) (114,149) (126,052)

PP&E—net 117,907 116,655 116,516 116,613 116,211 115,308 113,905 112,003

Depreciation Expense Forecast Development: Depreciation expense forecast on existing PP&E:
Existing PP&E at cost: 188,054 9,403 9,403 9,403 9,403 9,403
Remaining balance to be depreciated. 116,516 107,113 97,711 88,308 78,905 69,503
PP&E Purchases: Depreciation expense forecasts on new PP&E:
Capex Year +1 10,000 500 500 500 500 500
Capex Year +2 10,000 500 500 500 500
Capex Year +3 10,000 500 500 500
Capex Year +4 10,000 500 500
Capex Year +5 10,000 500
Total Depreciation Expense 9,903 10,403 10,903 11,403 11,903
Depreciation methods: 2013 2014 2015
PPE at Cost 178,678 182,634 188,054
Avg Depreciable PPE 180,656 185,344
Depreciation Expense 8,800 9,100 9,400
Implied Avg. Useful Life in Years 19.9 19.7
Useful Life Forecast Assumption: (in years) 20.0
Exhibit 10.C
 Walmart Stores—Statement of Cash Flows Forecasts (Integrative Case 10.1) (amounts in millions)
Actuals Forecasts
IMPLIED STATEMENT OF CASH FLOWS 2014 2015 Year +1 Year +2 Year +3 Year +4 Year +5 Year +6
Net Income 17,099 15,080 15,108 15,449 15,808 16,179 16,564 17,060
Add back depreciation expense (net) 5,208 5,559 9,903 10,403 10,903 11,403 11,903 3,782
Add back amortization expense (net) 0 0 0 0 0 0 0 0
<Increase> Decrease in receivables - net (101) 1,154 (112) (115) (117) (119) (122) (186)
<Increase> Decrease in inventories (283) 672 (1,003) (909) (928) (946) (965) (1,477)
<Increase> Decrease in prepaid expenses (315) 783 (29) (29) (30) (31) (31) (48)
<Increase> Decrease in other current assets (1) 460 0 0 0 0 0 0 0
<Increase> Decrease in other current assets (2) 0 0 0 0 0 0 0 0
Increase <Decrease> in accounts payable - trade 995 77 16 758 785 801 817 1,250
Increase <Decrease> in current accrued liabilities 359 455 392 400 408 416 424 649
Increase <Decrease> in income taxes payable 55 (500) 10 11 11 11 11 17
Increase <Decrease> in other current liabilities (1) (89) 0 0 0 0 0 0 0
Increase <Decrease> in other current liabilities (2) 0 0 0 0 0 0 0 0
Net change in deferred tax assets and liabilities 788 (1,484) 146 149 152 155 158 242
Increase <Decrease> in long-term accrued liabilities 0 0 0 0 0 0 0 0
Increase <Decrease> in other noncurrent liabilities (1) 0 0 0 0 0 0 0 0
Increase <Decrease> in other noncurrent liabilities (2) 0 0 0 0 0 0 0 0
Net Cash Flows from Operations 24,176 21,796 24,431 26,116 26,992 27,869 28,759 21,290

10-17
<Increase> Decrease in property, plant, & equip. at cost (3,956) (5,420) (10,000) (10,000) (10,000) (10,000) (10,000) (7,142)
<Increase> Decrease in marketable securities 0 0 0 0 0 0 0 0
<Increase> Decrease in investment securities 0 0 0 0 0 0 0 0
<Increase> Decrease in amortizable intangible assets (net) 0 0 0 0 0 0 0 0
<Increase> Decrease in goodwill and nonamort. intangibles 1,408 1,407 (334) (341) (347) (354) (361) (553)
<Increase> Decrease in other noncurrent assets (1) 0 0 0 0 0 0 0 0
<Increase> Decrease in other noncurrent assets (2) 694 (676) (123) (125) (128) (130) (133) (203)
Net Cash Flows from Investing Activities (1,854) (4,689) (10,457) (10,466) (10,475) (10,484) (10,494) (7,898)
Increase <Decrease> in short-term debt (5,412) (666) 180 186 191 197 203 209
Increase <Decrease> in long-term debt (1,064) 535 1,321 1,361 1,401 1,443 1,487 1,531
Increase <Decrease> in redeemable noncontrolling interests (1,491) 0 0 0 0 0 0 0
Increase <Decrease> in common stock + paid in capital 100 (663) 64 66 68 70 72 74
Increase <Decrease> in accum. OCI (4,172) (4,429) 0 0 0 0 0 0
Increase <Decrease> in treasury stock and other equity adjs. 0 0 0 0 0 0 0 0
Dividends (7,152) (10,450) (10,183) (10,326) (10,477) (10,633) (10,794) (13,219)
Increase <Decrease> in noncontrolling interests (1,277) (1,864) (386) (386) (386) (386) (386) (306)
Net Cash Flows from Financing Activities (20,468) (17,537) (9,005) (9,101) (9,203) (9,309) (9,420) (11,711)
Net Change in Cash 1,854 (430) 4,970 6,550 7,314 8,075 8,846 1,682
Check Figure:
Net change in cash - Change in cash balance 0 0 0 0 0 0 0 0

© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Chapter 10
Forecasting Financial Statements
Chapter 10
Forecasting Financial Statements

b. The increasing balances in cash through Year +5 result because cash flow from
operations and from new borrowing are more than sufficient to finance Walmart’s
growth and capital expenditures on property, plant, and equipment. The excess cash
presents a number of potential agency problems for financial management of
Walmart. Students can discuss how the excess cash is underinvested because the rate
of return expected on cash (1.5%) is lower than the cost of debt and equity capital for
Walmart, so the excess cash is value-destroying. Students also can discuss how the
excess cash creates agency problems, in which the cash may be mismanaged (used for
value-destroying acquisitions) or subject to embezzlement. The excess cash also
signals Walmart shareholders that the firm is not utilizing company resources
efficiently.

c. After the plug is changed from cash to dividends, the new financial statement
forecasts for Walmart are presented next in Exhibits 10.D–10.F. The benefits from
increasing cash dividend payments stem from reducing Walmart’s exposure to the
agency and underinvestment problems mentioned in Requirement b above. Students
also can consider whether the dividends provide a significant yield for Walmart
common shareholders and what they signal about management’s expectations for
persistent future cash flows. You also can point out that the shift from plugging cash
to dividends affects all these statements (income statements, balance sheets, and cash
flows).

10-18
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in whole or in part.
 Exhibit 10.D
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Walmart Stores—Revised Income Statement Forecasts (Integrative Case 10.1) (amounts in millions)
Actuals Forecasts
Year 2013 2014 2015 Year +1 Year +2 Year +3 Year +4 Year +5 Year +6
INCOME STATEMENT
Revenues 476,294 485,651 482,130 491,773 501,608 511,640 521,873 532,310 548,280
common size 100.0% 100.0% 100.0% 2.0% 2.0% 2.0% 2.0% 2.0%
rate of change 2.0% (0.7%) Assume steady 2.0% revenue growth.
Cost of goods sold (358,069) (365,086) (360,984) (368,829) (376,206) (383,730) (391,405) (399,233) (411,210)
common size (75.2%) (75.2%) (74.9%) (75.0%) (75.0%) (75.0%) (75.0%) (75.0%)
rate of change 2.0% (1.1%) Assume steady cost of goods sold as a percent of sales.
Gross Profit 118,225 120,565 121,146 122,943 125,402 127,910 130,468 133,078 137,070
common size 24.8% 24.8% 25.1% 25.0% 25.0% 25.0% 25.0% 25.0% 25.0%
rate of change 2.0% 0.5% 1.5% 2.0% 2.0% 2.0% 2.0%

Selling, general and administrative expenses (91,353) (93,418) (97,041) (98,355) (100,322) (102,328) (104,375) (106,462) (109,656)
common size
10-19

(19.2%) (19.2%) (20.1%) (20.0%) (20.0%) (20.0%) (20.0%) (20.0%)

rate of change 2.3% 3.9% Assume steady SG&A expense as a percent of sales.
Operating Profit 26,872 27,147 24,105 24,589 25,080 25,582 26,094 26,616 27,414
common size 5.6% 5.6% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0%
rate of change 1.0% (11.2%) 2.0% 2.0% 2.0% 2.0% 2.0%
168 254 358 474 601
Interest income 119 113 81 131 131 131 131 131 134
common size 0.0% 0.0% 0.0% 1.5% 1.5% 1.5% 1.5% 1.5%

Forecasting Financial Statements

rate of change (5.0%) (28.3%) Assume 1.5% interest earned on average balance in cash.
Interest expense (2,335) (2,461) (2,548) (2,539) (2,615) (2,694) (2,775) (2,858) (2,944)
common size (0.5%) (0.5%) (0.5%) (5.0%) (5.0%) (5.0%) (5.0%) (5.0%)
rate of change 5.4% 3.5% Weighted average interest rate on financial liabilities.
Income before Tax 24,656 24,799 21,638 22,180 22,596 23,019 23,450 23,888 24,605
common size 5.2% 5.1% 4.5% 4.5% 4.5% 4.5% 4.5% 4.5% 4.5%
rate of change 0.6% (12.7%) 2.5% 1.9% 1.9% 1.9% 1.9%

Chapter 10
Income tax expense (8,105) (7,985) (6,558) (7,098) (7,231) (7,366) (7,504) (7,644) (7,874)
common size (1.7%) (1.6%) (1.4%) (32.0%) (32.0%) (32.0%) (32.0%) (32.0%)
rate of change (1.5%) (17.9%) Assume effective income tax rate equal to that of past two years.
 Forecasting Financial Statements
Chapter 10
Actuals Forecasts
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Year 2013 2014 2015 Year +1 Year +2 Year +3 Year +4 Year +5 Year +6

Income (Loss) from discontinued operations 144 285 0 0 0 0 0 0 0

common size 0.0% 0.1% 0.0% 0.0 0.0 0.0 0.0 0.0
rate of change 97.9% (100.0%) Assume no additional discontinued operations.
Net Income 16,695 17,099 15,080 15,082 15,365 15,653 15,946 16,244 16,731
common size 3.5% 3.5% 3.1% 3.1% 3.1% 3.1% 3.1% 3.1% 3.1%
rate of change 2.4% (11.8%) 0.0% 1.9% 1.9% 1.9% 1.9% 3.0%
Net income attributable to noncontrolling
interests (673) (736) (386) (386) (386) (386) (386) (386) (398)
common size (0.1%) (0.2%) (0.1%) 12.6% 12.6% 12.6% 12.6% 12.6%
rate of change 9.4% (47.6%) Assume noncontrolling interests earn a 12.6% rate of return.
Net Income attributable to common
shareholders 16,022 16,363 14,694 14,696 14,979 15,267 15,560 15,858 16,334
common size 3.4% 3.4% 3.0% 3.0% 3.0% 3.0% 3.0% 3.0% 3.0%
rate of change 2.1% (10.2%) 0.0% 1.9% 1.9% 1.9% 1.9% 3.0%
10-20

Other comprehensive income items (2,409) (4,172) (4,429) 0 0 0 0 0 0

common size (0.5%) (0.9%) (0.9%) 0.0 0.0 0.0 0.0 0.0
rate of change 73.2% 6.2% Assume random walk with mean zero.
Comprehensive Income 14,286 12,927 10,651 14,696 14,979 15,267 15,560 15,858 16,334
common size 3.0% 2.7% 2.2% 3.0% 3.0% 3.0% 3.0% 3.0% 3.0%
rate of change (9.5%) (17.6%) 38.0% 1.9% 1.9% 1.9% 1.9% 3.0%
 Exhibit 10.E
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Walmart Stores—Revised Balance Sheet Forecasts (Integrative Case 10.1) (amounts in millions)
Actuals Forecasts
2013 2014 2015 Year +1 Year +2 Year +3 Year +4 Year +5 Year +6
BALANCE SHEET
ASSETS:
Cash and cash equivalents 7,281 9,135 8,705 8,705 8,705 8,705 8,705 8,705 8,966
common size 3.6% 4.5% 4.4% 0.0 0.0 0.0 0.0 0.0
rate of change 25.5% (4.7%) Assume cash remains constant and dividends is the financial flexible account.
Accounts and notes receivable—net 6,677 6,778 5,624 5,736 5,851 5,968 6,088 6,209 6,396
common size 3.3% 3.3% 2.8% 2.0% 5.0% 5.0% 5.0% 5.0%
rate of change 1.5% (17.0%) Assume accounts receivable grow at the same rate as sales.
Inventories 44,858 45,141 44,469 45,472 46,382 47,309 48,255 49,220 50,697
common size 21.9% 22.2% 22.3% 45.0 45.0 45.0 45.0 45.0
rate of change 0.6% (1.5%) Assume ending inventory amounts to 45 days COGS.
Prepaid expenses and other current assets 1,909 2,224 1,441 1,470 1,499 1,529 1,560 1,591 1,639
common size 0.9% 1.1% 0.7% 2.0% 2.0% 2.0% 2.0% 2.0%
rate of change 16.5% (35.2%) Assume growth with SG&A expenses, which grow with sales.
Current Assets of Discontinued Segments 460 0 0 0 0 0 0 0 0
common size 0.2% 0.0% 0.0% 0% 0% 0% 0% 0% 0%
10-21

rate of change (100.0%) Assume no additional discontinued operations.

Current Assets 61,185 63,278 60,239 61,383 62,437 63,512 64,608 65,726 67,698
common size 29.9% 31.1% 30.2% 30.5% 30.8% 31.3% 31.8% 32.4% 32.4%
rate of change 3.4% (4.8%) 1.9% 1.7% 1.7% 1.7% 1.7% 3.0%
Property, plant, and equipment—at cost 178,678 182,634 188,054 198,054 208,054 218,054 228,054 238,054 245,196
common size 87.3% 89.8% 94.2%
rate of change 2.2% 3.0% PP&E assumptions—see schedule in forecast development.
Accumulated depreciation (60,771) (65,979) (71,538) (81,441) (91,843) (102,746) (114,149) (126,052) (129,833)

Forecasting Financial Statements

common size (29.7%) (32.4%) (35.8%)
rate of change 8.6% 8.4% See depreciation schedule in forecast development worksheet.
Goodwill 19,510 18,102 16,695 17,029 17,369 17,717 18,071 18,433 18,986
common size 9.5% 8.9% 8.4% 2.0% 2.0% 2.0% 2.0% 2.0%
rate of change (7.2%) (7.8%) Assume growth with sales.
Other assets 6,149 5,455 6,131 6,254 6,379 6,506 6,636 6,769 6,972
common size 3.0% 2.7% 3.1% 2.0% 2.0% 2.0% 2.0% 2.0%
rate of change (11.3%) 12.4% Assume growth with sales.
Total Assets 204,751 203,490 199,581 201,279 202,396 203,043 203,221 202,930 209,018
common size 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%

Chapter 10
rate of change (0.6%) (1.9%) 0.9% 0.6% 0.3% 0.1% (0.1%) 3.0%
 Forecasting Financial Statements
Chapter 10
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Actuals Forecasts
2013 2014 2015 Year +1 Year +2 Year +3 Year +4 Year +5 Year +6
LIABILITIES:
Accounts payable 37,415 38,410 38,487 38,503 39,261 40,047 40,847 41,664 42,914
common size 18.3% 18.9% 19.3% 38.0 38.0 38.0 38.0 38.0
rate of change 2.7% 0.2% Assume a 38-day payment period consistent with prior years.
Current accrued expenses 18,793 19,152 19,607 19,999 20,399 20,807 21,223 21,648 22,297
common size 9.2% 9.4% 9.8% 2.0% 2.0% 2.0% 2.0% 2.0%
rate of change 1.9% 2.4% Assume growth with SG&A expenses, which grow with sales.
Notes payable and short-term debt 7,670 1,592 2,708 2,789 2,873 2,959 3,048 3,139 3,233
common size 3.7% 0.8% 1.4% 3.0% 3.0% 3.0% 3.0% 3.0%
rate of change (79.2%) 70.1% Assume 3% growth, consistent with rate of growth in total assets.
Current maturities of long-term debt 4,412 5,078 3,296 3,395 3,497 3,602 3,710 3,821 3,936
common size 2.2% 2.5% 1.7% 3.0% 3.0% 3.0% 3.0% 3.0%
rate of change 15.1% (35.1%) Assume 3% growth, consistent with rate of growth in total assets.
Income taxes payable 966 1,021 521 531 542 553 564 575 592
common size 0.5% 0.5% 0.3% 2.0% 2.0% 2.0% 2.0% 2.0%
rate of change 5.7% (49.0%) Assume 2% growth per year.
Current liabilities of discontinued operations 89 0 0 0 0 0 0 0 0
common size 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%
10-22

rate of change (100.0%) Assume no additional discontinued operations.

Current Liabilities 69,345 65,253 64,619 65,218 66,572 67,967 69,392 70,848 72,973
common size 33.9% 32.1% 32.4% 32.4% 32.9% 33.5% 34.1% 34.9% 34.9%
rate of change (5.9%) (1.0%) 0.9% 2.1% 2.1% 2.1% 2.1% 3.0%
Long-term debt obligations 44,559 43,495 44,030 45,351 46,711 48,113 49,556 51,043 52,574
common size 21.8% 21.4% 22.1% 3.0% 3.0% 3.0% 3.0% 3.0%
rate of change (2.4%) 1.2% Assume 3% growth, consistent with rate of growth in total assets.
Deferred tax liabilities—noncurrent 8,017 8,805 7,321 7,467 7,617 7,769 7,924 8,083 8,325
common size 3.9% 4.3% 3.7% 2.0% 2.0% 2.0% 2.0% 2.0%
rate of change 9.8% (16.9%) Assume 2% growth per year.
Redeemable noncontrolling interest 1,491 0 0 0 0 0 0 0 0
common size 0.7% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0%
rate of change (100.0%) Assume remains zero.
Total Liabilities 123,412 117,553 115,970 118,036 120,900 123,849 126,873 129,973 133,873
common size 60.3% 57.8% 58.1% 58.6% 59.7% 61.0% 62.4% 64.0% 64.0%
rate of change (4.7%) (1.3%) 1.8% 2.4% 2.4% 2.4% 2.4% 3.0%
 SHAREHOLDERS’ EQUITY
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Common stock + Additional paid in capital 2,685 2,785 2,122 2,186 2,251 2,319 2,388 2,460 2,534
common size 1.3% 1.4% 1.1% 3.0% 3.0% 3.0% 3.0% 3.0%
rate of change 3.7% (23.8%) Assume 3% growth, consistent with rate of growth in total assets.
Retained earnings 76,566 85,777 90,021 89,589 87,776 85,407 82,491 79,029 81,052
common size 37.4% 42.2% 45.1%
rate of change 12.0% 4.9% Add net income and subtract dividends and share repurchases; see forecast box below.
Accum. other comprehensive income (loss) (2,996) (7,168) (11,597) (11,597) (11,597) (11,597) (11,597) (11,597) (11,597)
common size (1.5%) (3.5%) (5.8%) 0.0 0.0 0.0 0.0 0.0
rate of change 139.3% 61.8% Add accumulated other comprehensive income items from income statement
Total Common Shareholders’ Equity 76,255 81,394 80,546 80,178 78,430 76,129 73,283 69,892 71,988
common size 37.2% 40.0% 40.4% 39.8% 38.8% 37.5% 36.1% 34.4%
rate of change 6.7% (1.0%) (0.5%) (2.2%) (2.9%) (3.7%) (4.6%)
Noncontrolling interests 5,084 4,543 3,065 3,065 3,065 3,065 3,065 3,065 3,157
common size 2.5% 2.2% 1.5% 0.0 0.0 0.0 0.0 0.0
rate of change (10.6%) (32.5%) Assume earnings attributable to noncontrolling interests paid in dividends.
Total Equity 81,339 85,937 83,611 83,243 81,495 79,194 76,348 72,957 75,145
common size 39.7% 42.2% 41.9% 41.4% 40.3% 39.0% 37.6% 36.0%
rate of change 5.7% (2.7%) (0.4%) (2.1%) (2.8%) (3.6%) (4.4%)
Total Liabilities and Equities 204,751 203,490 199,581 201,279 202,396 203,043 203,221 202,930 209,018
common size 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
rate of change (0.6%) (1.9%) 0.9% 0.6% 0.3% 0.1% (0.1%) 3.0%
10-23

Check figures: Balance Sheet A=L+OE? 0 0 0 0 0 0 0 0

Initial adjustment needed to balance the balance sheet:
(4,955) (6,501) (7,224) (7,940) (8,660) (3,330)

Dividends and share repurchases forecasts:

Common dividends: (6,172) (6,291) (6,412) (6,535) (6,660) (6,860)
(42.0%) (42.0%) (42.0%) (42.0%) (42.0%)
Assume dividend payout of net income.
Share repurchases (4,000) (4,000) (4,000) (4,000) (4,000) (4,120)

Forecasting Financial Statements

(4,000) (4,000) (4,000) (4,000) (4,000)
Assume $4,000 in share repurchases per year.
Total dividends: (10,172) (10,291) (10,412) (10,535) (10,660) (10,980)
Total dividends and share repurchases forecast amounts.

Flexible Financial Account: Additional Dividends

Original Forecast Amounts:
Additional Dividends 0 0 0 0 0
0 0 0 0 0
Initial assumption—zero additional dividends.

Chapter 10
Implied adjustments: (4,955) (6,501) (7,224) (7,940) (8,660) (3,330)
Adjustment needed to balance the balance sheet, from above.
Total: (4,955) (6,501) (7,224) (7,940) (8,660) (3,330)
Additional dividend payments.
 Forecasting Financial Statements
Chapter 10
Exhibit 10.F
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Walmart Stores—Revised Statement of Cash Flows Forecasts (Integrative Case 10.1) (amounts in millions)
Actuals Forecasts
IMPLIED STATEMENT OF CASH FLOWS 2014 2015 Year +1 Year +2 Year +3 Year +4 Year +5 Year +6
Net Income 17,099 15,080 15,082 15,365 15,653 15,946 16,244 16,731
Add back depreciation expense (net) 5,208 5,559 9,903 10,403 10,903 11,403 11,903 3,782
Add back amortization expense (net) 0 0 0 0 0 0 0 0
<Increase> Decrease in receivables - net (101) 1,154 (112) (115) (117) (119) (122) (186)
<Increase> Decrease in inventories (283) 672 (1,003) (909) (928) (946) (965) (1,477)
<Increase> Decrease in prepaid expenses (315) 783 (29) (29) (30) (31) (31) (48)
<Increase> Decrease in other current assets (1) 460 0 0 0 0 0 0 0
<Increase> Decrease in other current assets (2) 0 0 0 0 0 0 0 0
Increase <Decrease> in accounts payable - trade 995 77 16 758 785 801 817 1,250
Increase <Decrease> in current accrued liabilities 359 455 392 400 408 416 424 649
Increase <Decrease> in income taxes payable 55 (500) 10 11 11 11 11 17
Increase <Decrease> in other current liabilities (1) (89) 0 0 0 0 0 0 0
Increase <Decrease> in other current liabilities (2) 0 0 0 0 0 0 0 0
Net change in deferred tax assets and liabilities 788 (1,484) 146 149 152 155 158 242
Increase <Decrease> in long-term accrued liabilities 0 0 0 0 0 0 0 0
Increase <Decrease> in other noncurrent liabilities (1) 0 0 0 0 0 0 0 0
10-24

Increase <Decrease> in other noncurrent liabilities (2) 0 0 0 0 0 0 0 0

Net Cash Flows from Operations 24,176 21,796 24,406 26,032 26,837 27,636 28,440 20,961
<Increase> Decrease in property, plant, & equip. at cost (3,956) (5,420) (10,000) (10,000) (10,000) (10,000) (10,000) (7,142)
<Increase> Decrease in marketable securities 0 0 0 0 0 0 0 0
<Increase> Decrease in investment securities 0 0 0 0 0 0 0 0
<Increase> Decrease in amortizable intangible assets (net) 0 0 0 0 0 0 0 0
<Increase> Decrease in goodwill and nonamort. intangibles 1,408 1,407 (334) (341) (347) (354) (361) (553)
<Increase> Decrease in other noncurrent assets (1) 0 0 0 0 0 0 0 0
<Increase> Decrease in other noncurrent assets (2) 694 (676) (123) (125) (128) (130) (133) (203)
Net Cash Flows from Investing Activities (1,854) (4,689) (10,457) (10,466) (10,475) (10,484) (10,494) (7,898)
Increase <Decrease> in short-term debt (5,412) (666) 180 186 191 197 203 209
Increase <Decrease> in long-term debt (1,064) 535 1,321 1,361 1,401 1,443 1,487 1,531
Increase <Decrease> in redeemable noncontrolling interests (1,491) 0 0 0 0 0 0 0
Increase <Decrease> in common stock + paid in capital 100 (663) 64 66 68 70 72 74
Increase <Decrease> in accum. OCI (4,172) (4,429) 0 0 0 0 0 0
Increase <Decrease> in treasury stock and other equity adjs. 0 0 0 0 0 0 0 0
Dividends (7,152) (10,450) (15,128) (16,792) (17,636) (18,475) (19,321) (14,311)
Increase <Decrease> in noncontrolling interests (1,277) (1,864) (386) (386) (386) (386) (386) (306)
Net Cash Flows from Financing Activities (20,468) (17,537) (13,949) (15,567) (16,362) (17,151) (17,946) (12,802)
Net Change in Cash 1,854 (430) 0 0 0 0 0 261
Check Figure:
Net change in cash - Change in cash balance 0 0 0 0 0 0 0 0
 Chapter 10
Forecasting Financial Statements

d. Exhibit 10.G presents profitability and risk ratios for Walmart based on the
financial statement forecasts originally developed (with the plug to cash) and
the revised forecasts (with the plug to dividends). The projections indicate a
declining ROCE as well as a declining ROA for Walmart with the plug to cash,
the result of a declining total assets turnover. The ROCE in Year +5 is 22.2%
with the revised forecasts, whereas it is only 15.7% under the original forecasts.
Similarly, the ROA in Year +5 is 9.0% under the revised forecasts and only
7.9% under the original forecasts. Clearly, Walmart shareholders will prefer the
higher rates of return under the increased dividend policy.

10-25
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
 Exhibit 10.G

Forecasting Financial Statements

Chapter 10
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Walmart Stores—Projected Financial Statement Ratios (Integrative Case 10.1)

Originally Developed Forecasts (with Plug to Cash)
Actuals Forecasts
2013 2014 2015 Year +1 Year +2 Year +3 Year +4 Year +5 Year +6
FORECAST VALIDITY CHECK DATA:
GROWTH
Revenue Growth Rates: 1.6% 2.0% (0.7%) 2.0% 2.0% 2.0% 2.0% 2.0% 3.0%
Net Income Growth Rates: (5.7%) 2.1% (10.2%) 0.2% 2.3% 2.3% 2.3% 2.4% 3.0%
Total Asset Growth Rates 0.8% (0.6%) (1.9%) 3.3% 3.7% 3.7% 3.7% 3.7% 3.1%

RETURN ON ASSETS (based on reported amounts):

Profit Margin for ROA 3.8% 3.9% 3.5% 3.4% 3.4% 3.4% 3.5% 3.5% 3.5%
× Asset Turnover 2.3 2.4 2.4 2.4 2.4 2.3 2.3 2.3 2.3
= Return on Assets 8.9% 9.2% 8.3% 8.3% 8.2% 8.1% 8.0% 7.9% 7.9%

RETURN ON ASSETS (excluding the effects of nonrecurring items):

10-26

Profit Margin for ROA 3.8% 3.8% 3.5% 3.4% 3.4% 3.4% 3.5% 3.5% 3.5%
× Asset Turnover 2.3 2.4 2.4 2.4 2.4 2.3 2.3 2.3 2.3
= Return on Assets 8.9% 9.0% 8.3% 8.3% 8.2% 8.1% 8.0% 7.9% 7.9%

RETURN ON COMMON EQUITY (based on reported amounts):

Profit Margin for ROCE 3.4% 3.4% 3.0% 3.0% 3.0% 3.0% 3.0% 3.0% 3.0%
× Asset Turnover 2.3 2.4 2.4 2.4 2.4 2.3 2.3 2.3 2.3
× Capital Structure Leverage 2.7 2.6 2.5 2.4 2.4 2.4 2.3 2.3 2.3
= Return on Common Equity 21.0% 20.8% 18.1% 17.8% 17.2% 16.7% 16.2% 15.7% 15.5%

RETURN ON COMMON EQUITY (excluding the effects of nonrecurring items):

Profit Margin for ROCE 3.3% 3.3% 3.0% 3.0% 3.0% 3.0% 3.0% 3.0% 3.0%
× Asset Turnover 2.3 2.4 2.4 2.4 2.4 2.3 2.3 2.3 2.3
× Capital Structure Leverage 2.7 2.6 2.5 2.4 2.4 2.4 2.3 2.3 2.3
= Return on Common Equity 20.8% 20.4% 18.1% 17.8% 17.2% 16.7% 16.2% 15.7% 15.5%
 OPERATING PERFORMANCE:
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Gross Profit / Revenues 24.8% 24.8% 25.1% 25.0% 25.0% 25.0% 25.0% 25.0% 25.0%
Operating Profit Before Taxes / Revenues 5.6% 5.6% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0%

ASSET TURNOVER:
Revenues / Avg. Accounts Receivable 70.9 72.2 77.8 86.6 86.6 86.6 86.6 86.6 87.0
COGS / Average Inventory 8.1 8.1 8.1 8.2 8.2 8.2 8.2 8.2 8.2
Revenues / Average Fixed Assets 4.1 4.1 4.1 4.2 4.3 4.4 4.6 4.7 4.8

LIQUIDITY:
Current Ratio 0.9 1.0 0.9 1.0 1.1 1.2 1.3 1.4 1.4
Quick Ratio 0.2 0.2 0.2 0.3 0.4 0.5 0.6 0.7 0.7

SOLVENCY:
Total Liabilities / Total Assets 60.3% 57.8% 58.1% 57.2% 56.5% 55.8% 55.1% 54.5% 54.4%
Total Liabilities / Total Equity 151.7% 136.8% 138.7% 138.6% 134.4% 130.4% 126.6% 123.0% 122.6%
Interest Coverage Ratio 11.6 11.1 9.5 9.7 9.7 9.6 9.6 9.5 9.5
10-27

Revised Forecasts (with Plug to Dividends):

Actuals Forecasts
2013 2014 2015 Year +1 Year +2 Year +3 Year +4 Year +5 Year +6
FORECAST VALIDITY CHECK DATA:
GROWTH
Revenue Growth Rates: 1.6% 2.0% (0.7%) 2.0% 2.0% 2.0% 2.0% 2.0% 3.0%
Net Income Growth Rates: (5.7%) 2.1% (10.2%) 0.0% 1.9% 1.9% 1.9% 1.9% 3.0%

Forecasting Financial Statements

Total Asset Growth Rates 0.8% (0.6%) (1.9%) 0.9% 0.6% 0.3% 0.1% (0.1%) 3.0%

RETURN ON ASSETS (based on reported amounts):

Profit Margin for ROA 3.8% 3.9% 3.5% 3.4% 3.4% 3.4% 3.4% 3.4% 3.4%
× Asset Turnover 2.3 2.4 2.4 2.5 2.5 2.5 2.6 2.6 2.7
= Return on Assets 8.9% 9.2% 8.3% 8.4% 8.5% 8.6% 8.8% 9.0% 9.1%

RETURN ON ASSETS (excluding the effects of nonrecurring items):

Chapter 10
Profit Margin for ROA 3.8% 3.8% 3.5% 3.4% 3.4% 3.4% 3.4% 3.4% 3.4%
× Asset Turnover 2.3 2.4 2.4 2.5 2.5 2.5 2.6 2.6 2.7
= Return on Assets 8.9% 9.0% 8.3% 8.4% 8.5% 8.6% 8.8% 9.0% 9.1%
 Forecasting Financial Statements
Chapter 10
© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Actuals Forecasts
2013 2014 2015 Year +1 Year +2 Year +3 Year +4 Year +5 Year +6

RETURN ON COMMON EQUITY (based on reported amounts):

Profit Margin for ROCE 3.4% 3.4% 3.0% 3.0% 3.0% 3.0% 3.0% 3.0% 3.0%
× Asset Turnover 2.3 2.4 2.4 2.5 2.5 2.5 2.6 2.6 2.7
× Capital Structure Leverage 2.7 2.6 2.5 2.5 2.5 2.6 2.7 2.8 2.9
= Return on Common Equity 21.0% 20.8% 18.1% 18.3% 18.9% 19.8% 20.8% 22.2% 23.0%

RETURN ON COMMON EQUITY (excluding the effects of nonrecurring items):

Profit Margin for ROCE 3.3% 3.3% 3.0% 3.0% 3.0% 3.0% 3.0% 3.0% 3.0%
× Asset Turnover 2.3 2.4 2.4 2.5 2.5 2.5 2.6 2.6 2.7
× Capital Structure Leverage 2.7 2.6 2.5 2.5 2.5 2.6 2.7 2.8 2.9
= Return on Common Equity 20.8% 20.4% 18.1% 18.3% 18.9% 19.8% 20.8% 22.2% 23.0%

OPERATING PERFORMANCE:
Gross Profit / Revenues 24.8% 24.8% 25.1% 25.0% 25.0% 25.0% 25.0% 25.0% 25.0%
10-28

Operating Profit Before Taxes / Revenues 5.6% 5.6% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0% 5.0%

ASSET TURNOVER:
Revenues / Avg. Accounts Receivable 70.9 72.2 77.8 86.6 86.6 86.6 86.6 86.6 87.0
COGS / Average Inventory 8.1 8.1 8.1 8.2 8.2 8.2 8.2 8.2 8.2
Revenues / Average Fixed Assets 4.1 4.1 4.1 4.2 4.3 4.4 4.6 4.7 4.8

LIQUIDITY:
Current Ratio 0.9 1.0 0.9 0.9 0.9 0.9 0.9 0.9 0.9
Quick Ratio 0.2 0.2 0.2 0.2 0.2 0.2 0.2 0.2 0.2

SOLVENCY:
Total Liabilities / Total Assets 60.3% 57.8% 58.1% 58.6% 59.7% 61.0% 62.4% 64.0% 64.0%
Total Liabilities / Total Equity 151.7% 136.8% 138.7% 147.2% 154.1% 162.7% 173.1% 186.0% 186.0%
Interest Coverage Ratio 11.6 11.1 9.5 9.7 9.6 9.5 9.5 9.4 9.4
 Chapter 10
Forecasting Financial Statements

Case 10.2: Massachusetts Stove Company: Analyzing Strategic Options

I. Case Objectives
1. Design a spreadsheet for the preparation of pro forma financial statements that
has the flexibility to analyze various strategic options.

2. Use tools of financial statement analysis to evaluate strategic options for a

business that is approaching maturity.

II. Teaching Strategy

We begin discussion of this case by asking students to identify clues from the
financial statements for Year 3 to Year 7 that Massachusetts Stove Company is in a
maturing business. We next discuss some of the difficulties students encountered in
designing their spreadsheets. We then ask three students to present their pro forma
financial statements, one each for the best-case scenario, the most likely case
scenario, and the worst-case scenarios. Also ask those students to comment on the
profitability and risk ratios for their scenarios. Finally, open the discussion to all
students to discuss their recommendation to Massachusetts Stove Company. Each
of these items is discussed more fully below.

III. Responses to Case Questions

a. Clues Indicating the Maturity of Massachusetts Stove Company’s Business
i. Decrease in profit margin and increase in asset turnover during the last three
years indicate increased margin pressure but cutbacks in asset growth,
particularly capital expenditures.

ii. There is a buildup of cash on the balance sheet even after substantially
reducing debt.

iii. A counter clue is the substantial increase (15.1%) in sales between Year 6
and Year 7. Although sales growth has varied during the last five years, the
growth rate has always been positive. Thus, the financial statements do not
give convincing clues as to the maturity of the wood stove business. Perhaps
the direct-marketing niche of Massachusetts Stove Company has permitted
it to remain profitable while the rest of the industry has experienced more
significant decline.

b. Design of Spreadsheet
The most difficult issue in the design of the spreadsheet is the projection of
interest income on the income statement and cash on the balance sheet. The
approach was to project all amounts on the income statement except interest
income net of income taxes, all amounts on the balance sheet except cash and
retained earnings, and all amounts on the statement of cash flows except the
effects of interest income net of income taxes. When added to the ending
balance in cash from the previous period, the amounts of net cash flow each
period on the statement of cash flows gave a preliminary balance in cash at the

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end of the period. This preliminary balance in cash was then used to compute
the average balance in cash for the year on which interest income was
computed. Interest income net of income taxes was plugged back into the
income statement to compute final net income. Final net income was flowed
forward into retained earnings on the balance sheet. Finally, interest income net
of income taxes was added to the preliminary balance in cash at the end of the
period to obtain the final balance in cash for the balance sheet.
Use this case to emphasize that the design of spreadsheets should allow
flexibility in considering various alternatives. The different assumptions with
regard to sales growth, development costs, and selling expenses among the three
scenarios mean that students should be able to change assumptions without
having to change formulas in the spreadsheets. Students might design their
spreadsheets, as was done here, so that the assumptions appear at the bottom
and the formulas access these assumptions when students make computations.

c. Projected Financial Statements and Ratios

Exhibits 10.H–10.K of this teaching note present the projected financial
statements and ratios for the best-case scenario. Exhibits 10.L–10.O present
them for the most likely scenario, and Exhibits 10.P–10.S present them for the
worst-case scenario. We discuss below our observations about each scenario.

Best-Case Scenario—The best-case scenario results in financial ratios similar

to those of Massachusetts Stove Company in recent years. The profit margin
declines slightly between Year 7 and Year 9 as the firm incurs costs to gear up
its new product line but steadily increases in Year 10–Year 12 as a result of
economies of scale with respect to selling expenses. The asset turnover
increases, primarily as a result of an increasing fixed-asset turnover. Sales
increases are sufficient to provide economies of scale benefits for fixed capacity
costs. Massachusetts Stove Company decreases its financial leverage
continually as it repays its bank borrowing without adding additional borrowing
to finance capital expenditures or product development. The short-term liquidity
and long-term solvency ratios are strong throughout the five years.

Most Likely Scenario—The most likely scenario results in a declining profit

margin and asset turnover during the phase-in period as a result of incurring
development costs on the new stoves. Depreciation expense as a percentage of
sales increases while the fixed-asset turnover declines. The profit margin slowly
improves after the phase-in period as a result of reductions in the selling and
administrative expense percentage. The assets turnover slowly improves as well
as the fixed-asset turnover increases. By Year 12, the ROA and ROCE are
considerably less than their levels in Year 7. As with the best-case scenario, the
short-term liquidity and long-term solvency ratios appear strong.

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Worst-Case Scenario—The profit margin declines even further under the

worst-case scenario and turns negative in Year 10. The asset turnover again
increases beginning in Year 10 because of the increasing fixed-asset turnover.
The rate of return on assets and return on common shareholders’ equity decline
continually during the five years. The short-term liquidity risk ratios appear
satisfactory. The long-term solvency ratios, however, are at unsatisfactory
levels. The cash flow from operations to total liabilities ratio is below the 20%
considered desirable beginning in Year 9 and the interest coverage ratio is low
or negative in Year 9 to Year 12.

d. Assessment of Strategic Options

In evaluating the move into gas stoves, it is helpful to examine the financial
performance of Massachusetts Stove Company by assuming that it remains in
the wood-stove business and does not pursue the gas stove option. We prepared
pro forma financial statements assuming the business simply continues as it has
in the past. We assume capital expenditures of $20,000 each year and a six-year
depreciable life. We examine six different scenarios with respect to growth in
wood stove sales. The ROA and the ROCE under each scenario appear next.

Rate of Return on Assets

Sales Growth Year 7 Year 8 Year 9 Year 10 Year 11 Year 12
+0.04 13.14% 13.56% 13.23% 12.92% 12.60% 12.29%
+0.02 13.14% 13.19% 12.61% 12.11% 11.65% 11.23%
0.00 13.14% 12.83% 11.99% 11.29% 10.68% 10.16%
–0.02 13.14% 12.45% 11.37% 10.47% 9.71% 9.06%
–0.04 13.14% 12.08% 10.74% 9.65% 8.73% 7.95%
–0.10 13.14% 10.94% 8.85% 7.16% 5.74% 4.52%

Rate of Return on Common Shareholders’ Equity

+0.04 32.56% 27.84% 23.85% 21.09% 19.00% 17.40%
+0.02 32.56% 26.98% 22.60% 19.63% 17.47% 15.82%
0.00 32.56% 26.12% 21.34% 18.17% 15.90% 14.28%
–0.02 32.56% 25.24% 20.07% 16.69% 14.30% 12.53%
–0.04 32.56% 24.36% 18.79% 15.19% 12.66% 10.80%
–0.10 32.56% 21.65% 14.88% 10.56% 7.53% 5.25%

The most likely scenario from moving into the gas stove market provides rates
of return on assets in Year 12 similar to those above when sales of wood stoves
decrease approximately 1% each year and rates of return on common
shareholders’ equity when sales increase approximately 1% each year. The
worst-case scenario from moving into the gas stove market provides rates of
return worse than those above when sales of wood-stoves decrease by 10% each
year. On the other hand, the best-case scenario from moving into the gas stove
market provides rates of return on assets by Year 10 better than any of the
growth scenarios above for the wood stove market and better than those for
Year 7.

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The most compelling arguments for adding gas stoves to the product line are
as follows:

• Growth opportunities in the wood stove market appear limited.

• Massachusetts Stove Company has garnered a position in retail direct

marketing that it might now leverage with a related product line.

• Massachusetts Stove Company has a reputation for high efficiency,

attractive stoves among a relatively affluent customer base. The gas stoves
are a natural extension of this product line as the company’s original
customers age.

• The expansion into gas stoves can be done incrementally, adding one stove
in Year 9 and delaying work on the second stove until the success of the first
stove becomes clear.

• The second product line is insurance against further erosion in wood stove
sales and may make the company more valuable if shareholders decide to
sell.

The most compelling arguments for not adding gas stoves to the product line
are as follows:

• The market appears saturated already, with some companies up for sale.

• The EPA might institute health or safety regulations in this new industry
that would increase costs unexpectedly.

• The profitability ratios from instituting the most likely scenario are no better
than those from remaining in the wood-stove business only and
experiencing sales declines of 1–3% annually.

• There is a risk that gas stove sales will cannibalize wood stove sales.

• There are uncertainties with respect to projected demand and projected costs
whenever a firm moves into a new product.

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 Chapter 10
Forecasting Financial Statements

Exhibit 10.H
Massachusetts Stove Company
Projected Income Statements under Best-Case Scenario
(Case 10.2)

MASS. STOVE Year 7 Year 8 Year 9 Year 10 Year 11 Year 12

Income Statement Actual Projected Projected Projected Projected Projected
Sales:
Woodstoves 2,734,986 2,789,686 2,845,479 2,902,389 2,960,437 3,019,646
Gas Stoves — — 167,381 532,272 955,077 1,444,040
Total Sales 2,734,986 2,789,686 3,012,861 3,434,661 3,915,514 4,463,686
Cost of Goods Sold (1,380,820) (1,394,843) (1,506,430) (1,717,331) (1,957,757) (2,231,843)
Depreciation (72,321) (75,654) (100,654) (125,654) (129,821) (133,988)
Facilities Income 41,004 41,004 20,502 20,502 20,502 20,502
Facilities Costs (45,309) (45,309) (75,309) (75,309) (75,309) (75,309)
Selling Expenses (926,175) (948,493) (994,244) (1,099,092) (1,213,809) (1,339,106)
Administrative Expenses (111,199) (141,199) (171,199) (191,199) (191,199) (191,199)
Operating Income 240,166 225,191 185,526 246,579 368,121 512,743
Interest Income 16,665
Interest Expense (42,108) (38,135) (36,223) (34,163) (31,943) (29,546)
Net Income before Tax 214,723 187,056 149,303 212,416 336,178 483,198
Income Tax Expense (60,122) (52,376) (41,805) (59,476) (94,130) (135,295)
Net Income (Prelim.) 154,601 134,680 107,498 152,939 242,048 347,902
Interest Income (Net) 13,741 15,728 20,397 29,677 42,737
Net Income (Final) 148,422 123,226 173,336 271,725 390,639

ASSUMPTIONS
Sales Growth:
Woodstoves 0.02 0.02 0.02 0.02 0.02
Gas Stoves 0 0.06 0.12 0.12 0.12
Total Sales 0.02 0.08 0.14 0.14 0.14
Cost of Goods Sold/Sales 0.5 0.5 0.5 0.5 0.5
Developmental Costs 100,000 100,000 — — —
Depre. of Devel. Costs — 20,000 40,000 40,000 40,000
Capital Expenditures 20,000 30,000 30,000 25,000 25,000
Additional Depreciation 3,333 8,333 13,333 17,500 21,667
Facilities Income Dec. 0 –0.5 –0.5 –0.5 –0.5
Facilities Costs Inc. 0 30,000 30,000 30,000 30,000
Selling Exp./Sales 0.34 0.33 0.32 0.31 0.30
Administrative Exp. Inc. 30,000 30,000 20,000 — —
Interest Income 0.05 0.05 0.05 0.05 0.05
Interest Rate on Debt 0.068 0.068 0.068 0.068 0.068
Income Tax Rate 0.28 0.28 0.28 0.28 0.28

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Chapter 10
Forecasting Financial Statements

Exhibit 10.I
Massachusetts Stove Company
Projected Balance Sheets under Best-Case Scenario
(Case 10.2)

MASS. STOVE Year 7 Year 8 Year 9 Year 10 Year 11 Year 12

Balance Sheet Actual Projected Projected Projected Projected Projected
Assets
Cash 351,588 425,555 477,698 691,593 1,007,226 1,439,458
Accounts Receivable 5,997 6,117 6,606 7,531 8,586 9,788
Inventories 452,709 461,763 498,704 568,523 648,116 738,852
Total Current Assets 810,294 893,435 983,008 1,267,647 1,663,928 2,188,098
Fixed Assets:
Cost 1,257,673 1,377,673 1,507,673 1,537,673 1,562,673 1,587,673
Accumulated Depre. (630,125) (705,779) (806,434) (932,088) (1,061,909) (1,195,897)
Net 627,548 671,894 701,239 605,585 500,764 391,776
Total Assets 1,437,842 1,565,329 1,684,248 1,873,232 2,164,692 2,579,874
Liabilities and Sh. Eq.
Accounts Payable 47,809 48,765 52,666 60,040 68,445 78,028
Cur. Portion—L.T. Debt 27,036 29,200 31,400 33,900 36,600 39,500
Other Current Liabilities 257,252 262,397 283,389 323,063 368,292 419,853
Total Current Liabilities 332,097 340,362 367,455 417,003 473,337 537,381
Long-Term Debt 547,296 518,096 486,696 452,796 416,196 376,696
Deferred Income Taxes 6,369 6,369 6,369 6,369 6,369 6,369
Total Liabilities 885,762 864,827 860,520 876,168 895,902 920,446
Common Stock 2,000 2,000 2,000 2,000 2,000 2,000
Additional Paid-In Cap. 435,630 435,630 435,630 435,630 435,630 435,630
Retained Earnings 189,450 337,872 461,098 634,434 906,159 1,296,799
Treasury Stock (75,000) (75,000) (75,000) (75,000) (75,000) (75,000)
Total Share. Equity 552,080 700,502 823,728 997,064 1,268,789 1,659,429
Total Liab. & Sh. Eq. 1,437,842 1,565,329 1,684,248 1,873,232 2,164,692 2,579,874

ASSUMPTIONS
Cash Statement of Cash Flows
Accounts Receivable Growth Rate of Sales
Inventories Growth Rate of Cost of Goods Sold
Fixed Assets at Cost Growth Equal to Devel. Cost Plus Cap. Expend.
Accumulated Depre. Amort. of Develop. Costs and Cap. Expend.
Accounts Payable Growth Rate of Inventories
Cur. Portion—L.T. Debt Given in Case
Other Current Liabilities Growth Rate of Sales
Long-Term Debt Reduced by Current Portion of Debt
Deferred Income Taxes No Change
Contributed Capital No Change

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 Chapter 10
Forecasting Financial Statements

Exhibit 10.J
Massachusetts Stove Company
Projected Statements of Cash Flows under Best-Case Scenario
(Case 10.2)

MASS. STOVE Year 7 Year 8 Year 9 Year 10 Year 11 Year 12

State. of Cash Flows Actual Projected Projected Projected Projected Projected
Operations
Net Income (Prelim.) 154,601 134,680 107,498 152,939 242,048 347,902
Depreciation 72,321 75,654 100,654 125,654 129,821 133,988
Deferred Taxes 909 0 0 0 0 0
Change in Acct. Rec. 24,992 (120) (489) (925) (1,054) (1,202)
Change in Inventories (43,036) (9,054) (36,941) (69,819) (79,593) (90,736)
Change in Acct. Pay. 8,639 956 3,901 7,373 8,406 9,582
Change in Ot.Cur.Liab. 13,011 5,145 20,992 39,674 45,229 51,561
Cash Flow from Oper. 231,437 207,262 195,615 254,898 344,856 451,095
Investing
Capital Expenditures (22,921) (120,000) (130,000) (30,000) (25,000) (25,000)
Cash Flow from Invest. (22,921) (120,000) (130,000) (30,000) (25,000) (25,000)
Financing
Repayment of L.T. Debt (115,076) (27,036) (29,200) (31,400) (33,900) (36,600)
Cash Flow from Fin. (115,076) (27,036) (29,200) (31,400) (33,900) (36,600)
Net Change in Cash 93,440 60,226 36,415 193,498 285,956 389,495
Cash—Beg. of Year 258,148 351,588 425,555 477,698 691,593 1,007,226
Cash—End of Yr (Prelim.) 351,588 411,814 461,970 671,196 977,549 1,396,721
Interest Income 19,085 21,845 28,329 41,219 59,357
Inc. Taxes on Int. Inc. (5,344) (6,116) (7,932) (11,541) (16,620)
Cash Flow from Int. Inc. 13,741 15,728 20,397 29,677 42,737
Cash—End of Year (Final) 425,555 477,698 691,593 1,007,226 1,439,458

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Chapter 10
Forecasting Financial Statements

Exhibit 10.K
Massachusetts Stove Company
Projected Financial Statement Ratios under Best-Case Scenario
(Case 10.2)

MASS. STOVE Year 7 Year 8 Year 9 Year 10 Year 11 Year 12

Financial Ratios Actual Projected Projected Projected Projected Projected
Profit Margin for ROA 6.76% 6.30% 4.96% 5.76% 7.53% 9.23%
Assets Turnover 1.94 1.86 1.85 1.93 1.94 1.88
Return on Assets 13.14% 11.71% 9.19% 11.13% 14.60% 17.36%
Profit Margin for ROCE 5.65% 5.32% 4.09% 5.05% 6.94% 8.75%
Capital Structure Lev. 2.96 2.40 2.13 1.95 1.78 1.62
Return on Share. Equity 32.56% 23.70% 16.17% 19.04% 23.98% 26.68%
Cost of Goods Sold/Sales 50.48% 50.00% 50.00% 50.00% 50.00% 50.00%
Depreciation/Sales 2.64% 2.71% 3.34% 3.66% 3.32% 3.00%
Selling Expense/Sales 33.86% 34.00% 33.00% 32.00% 31.00% 30.00%
Admin. Expense/Sales 4.07% 5.06% 5.68% 5.57% 4.88% 4.28%
Interest Income/Sales 1.54% 1.37% 1.20% 0.99% 0.82% 0.66%
Inc. Tax Expense/Sales 2.20% 2.07% 1.59% 1.96% 2.70% 3.40%
Accounts Rec. Turnover 147.89 460.57 473.60 485.89 485.89 489.89
Inventory Turnover 3.2 3.05 31.4 3.22 3.22 3.22
Fixed-Asset Turnover 4.19 4.29 4.39 5.26 7.08 10.00
Current Ratio 2.44 2.62 2.68 3.04 3.52 4.07
Quick Ratio 1.08 1.27 1.32 1.68 2.15 2.70
Days Accounts Payable 11.15 12.55 11.99 11.51 11.51 11.51
Oper. Cash Flow/Cur. Liab. 63.36% 65.73% 59.72% 70.19% 84.13% 97.72%
Long-Term Debt Ratio 49.78% 42.52% 37.14% 31.23% 24.70% 18.50%
Debt-Equity Ratio 99.13% 73.96% 59.08% 45.41% 32.80% 22.70%
Oper. Cash Flow/Tot. Liab. 24.83% 25.25% 24.50% 31.70% 42.27% 54.38%
Interest Coverage Ratio 6.1 6.41 5.72 8.05 12.81 19.36

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 Chapter 10
Forecasting Financial Statements

Exhibit 10.L
Massachusetts Stove Company
Projected Income Statements under Most Likely Scenario
(Case 10.2)

MASS. STOVE Year 7 Year 8 Year 9 Year 10 Year 11 Year 12

Income Statement Actual Projected Projected Projected Projected Projected
Sales:
Woodstoves 2,734,986 2,680,286 2,626,681 2,574,147 2,522,664 2,472,211
Gas Stoves — — 107,211 323,779 549,137 783,898
Total Sales 2,734,986 2,680,286 2,733,892 2,897,926 3,071,801 3,256,109
Cost of Good Sold (1,380,820) (1,340,143) (1,366,946) (1,448,963) (1,535,901) (1,628,055)
Depreciation (72,321) (75,654) (104,654) (133,654) (137,821) (141,988)
Facilities Income 41,004 41,004 20,502 20,502 20,502 20,502
Facilities Costs (45,309) (45,309) (75,309) (75,309) (75,309) (75,309)
Selling Expenses (926,175) (911,297) (915,854) (956,315) (98,335) (1,041,955)
Administrative Expenses (111,199) (141,199) (171,199) (191,199) (191,199) (191,199)
Operating Income 240,166 207,687 120,432 112,987 153,738 198,106
Interest Income 16,665
Interest Expense (42,108) (38,135) (36,223) (34,163) (31,943) (29,546)
Net Income before Tax 214,723 169,552 84,209 78,824 121,795 168,560
Income Tax Expense (60,122) (47,475) (23,578) (22,071) (34,103) (47,197)
Net Income (Prelim.) 154,601 122,078 60,630 56,753 87,693 121,363
Interest Income (Net) 13,265 13,807 16,146 21,664 28,613
Net Income (Final) 135,343 74,437 72,899 109,357 149,977

ASSUMPTIONS
Sales Growth:
Woodstoves –0.02 –0.02 –0.02 –0.02 –0.02
Gas Stoves 0 0.04 0.08 0.08 0.08
Total Sales –0.02 0.02 0.06 0.06 0.06
Cost of Goods Sold/Sales 0.5 0.5 0.5 0.5 0.5
Developmental Costs 120,000 120,000 — — —
Depre. of Devel. Costs — 24,000 48,000 48,000 48,000
Capital Expenditures 20,000 30,000 30,000 25,000 25,000
Additional Depreciation 3,333 8,333 13,333 17,500 21,667
Facilities Income Dec. 0 –0.5 –0.5 –0.5 –0.5
Facilities Costs Inc. 0 30,000 30,000 30,000 30,000
Selling Exp./Sales 0.34 0.335 0.33 0.325 0.32
Administrative Exp. Inc. 30,000 30,000 20,000 — —
Interest Income 0.05 0.05 0.05 0.05 0.05
Interest Rate on Debt 0.068 0.068 0.068 0.068 0.068
Income Tax Rate 0.28 0.28 0.28 0.28 0.28

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Chapter 10
Forecasting Financial Statements

Exhibit 10.M
Massachusetts Stove Company
Projected Balance Sheets under Most Likely Scenario
(Case 10.2)

MASS. STOVE Year 7 Year 8 Year 9 Year 10 Year 11 Year 12

Balance Sheet Actual Projected Projected Projected Projected Projected
Assets
Cash 351,588 398,622 395,502 531,440 709,950 929,961
Accounts Receivable 5,997 5,877 5,995 6,354 6,736 7,140
Inventories 452,709 443,655 452,528 479,680 508,460 538,968
Total Current Assets 810,294 848,154 854,024 1,017,474 1,225,146 1,476,069
Fixed Assets:
Cost 1,257,673 1,397,673 1,547,673 1,577,673 1,602,673 1,627,673
Accumulated Depre. (630,125) (705,779) (810,434) (944,088) (1,081,909) (1,223,897)
Net 627,548 691,894 737,239 633,585 520,764 403,776
Total Assets 1,437,842 1,540,047 1,591,264 1,651,059 1,745,910 1,879,845
Liabilities and Sh. Eq.
Accounts Payable 47,809 46,853 47,790 50,657 53,697 56,919
Cur. Portion—L.T. Debt 27,036 29,200 31,400 33,900 36,600 39,500
Other Current Liabilities 257,252 252,107 257,149 272,578 288,933 306,269
Total Current Liabilities 332,097 328,160 336,339 357,135 379,229 402,687
Long-Term Debt 547,296 518,096 486,696 452,796 416,196 376,696
Deferred Income Taxes 6,369 6,369 6,369 6,369 6,369 6,369
Total Liabilities 885,762 852,625 829,404 816,300 801,794 785,752
Common Stock 2,000 2,000 2,000 2,000 2,000 2,000
Additional Paid-In Cap. 435,630 435,630 435,630 435,630 435,630 435,630
Retained Earnings 189,450 324,793 399,230 472,129 581,486 731,463
Treasury Stock (75,000) (75,000) (75,000) (75,000) (75,000) (75,000)
Total Share. Equity 552,080 687,423 761,860 834,759 944,116 1,094,093
Total Liab. and Sh. Eq. 1,437,842 1,540,047 1,591,264 1,651,059 1,745,910 1,879,845

ASSUMPTIONS
Cash Statement of Cash Flows
Accounts Receivable Growth Rate of Sales
Inventories Growth Rate of Cost of Goods Sold
Fixed Assets at Cost Growth Equal to Devel. Cost Plus Cap. Expend.
Accumulated Depre. Amort. of Develop. Costs and Cap. Expend.
Accounts Payable Growth Rate of Inventories
Cur. Portion—L.T. Debt Given in Case
Other Current Liabilities Growth Rate of Sales
Long-Term Debt Reduced by Current Portion of Debt
Deferred Income Taxes No Change
Contributed Capital No Change

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 Chapter 10
Forecasting Financial Statements

Exhibit 10.N
Massachusetts Stove Company
Projected Statements of Cash Flows under Most Likely Scenario
(Case 10.2)

MASS. STOVE Year 7 Year 8 Year 9 Year 10 Year 11 Year 12

State. of Cash Flows Actual Projected Projected Projected Projected Projected
Operations
Net Income (Prelim.) 154,601 122,078 60,630 56,753 87,693 121,363
Depreciation 72,321 75,654 104,654 133,654 137,821 141,988
Deferred Taxes 909 0 0 0 0 0
Change in Acct. Rec. 24,992 120 (118) (360) (381) (404)
Change in Inventories (43,036) 9,054 (8,873) (27,152) (28,781) (30,508)
Change in Acct. Pay. 8,639 (956) 937 2,867 3,039 3,222
Change in Ot.Cur.Liab. 13,011 (5,145) 5,042 15,429 16,355 17,336
Cash Flow from Oper. 231,437 200,805 162,273 181,193 215,746 252,997
Investing
Capital Expenditures (22,921) (140,000) (150,000) (30,000) (25,000) (25,000)
Cash Flow from Invest. (22,921) (140,000) (150,000) (30,000) (25,000) (25,000)
Financing
Repayment of L.T. Debt (115,076) (27,036) (29,200) (31,400) (33,900) (36,600)
Cash Flow from Fin. (115,076) (27,036) (29,200) (31,400) (33,900) (36,600)
Net Change in Cash 93,440 33,769 (16,927) 119,793 156,846 191,397
Cash—Beg. of Year 258,148 351,588 398,622 395,502 531,440 709,950
Cash—End of Yr (Prelim.) 351,588 385,357 381,695 515,294 688,286 901,347
Interest Income 18,424 19,176 22,425 30,090 39,741
Inc. Taxes on Int. Inc. (5,159) (5,369) (6,279) (8,425) (11,127)
Cash Flow from Int. Inc. 13,265 13,807 16,146 21,664 28,613
Cash—End of Year (Final) 398,622 395,502 531,440 709,950 929,961

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© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Chapter 10
Forecasting Financial Statements

Exhibit 10.O
Massachusetts Stove Company
Projected Financial Statement Ratios under Most Likely Scenario
(Case 10.2)

MASS. STOVE Year 7 Year 8 Year 9 Year 10 Year 11 Year 12

Financial Ratios Actual Projected Projected Projected Projected Projected
Profit Margin for ROA 6.76% 6.07% 3.68% 3.36% 4.31% 5.26%
Assets Turnover 1.94 1.80 1.75 1.79 1.81 1.80
Return on Assets 13.14% 10.93% 6.42% 6.01% 7.79% 9.45%
Profit Margin for ROCE 5.65% 5.05% 2.72% 2.52% 3.56% 4.61%
Capital Structure Lev. 2.96 2.40 2.16 2.03 1.91 1.78
Return on Share. Equity 32.56% 21.84% 10.27% 9.13% 12.30% 14.72%
Cost of Goods Sold/Sales 50.48% 50.00% 50.00% 50.00% 50.00% 50.00%
Depreciation/Sales 2.64% 2.82% 3.83% 4.61% 4.49% 4.36%
Selling Expense/Sales 33.86% 34.00% 33.50% 33.00% 32.50% 32.00%
Admin. Expense/Sales 4.07% 5.27% 6.26% 6.60% 6.22% 5.87%
Interest Income/Sales 1.54% 1.42% 1.32% 1.18% 1.04% 0.91%
Inc.Tax Expense/Sales 2.20% 1.96% 1.06% 0.98% 1.38% 1.79%
Accounts Rec. Turnover 147.89 451.45 460.57 469.34 469.34 469.34
Inventory Turnover 3.2 2.99 3.05 3.11 3.11 3.11
Fixed-Asset Turnover 4.19 4.06 3.83 4.23 5.32 7.04
Current Ratio 2.44 2.58 2.54 2.85 3.23 3.67
Quick Ratio 1.08 1.23 1.19 1.51 1.89 2.33
Days Accounts Payable 11.15 12.98 12.55 12.17 12.17 12.17
Oper. Cash Flow/Cur. Liab. 63.36% 64.84% 53.00% 56.91% 64.48% 72.03%
Long-Term Debt Ratio 49.78% 42.98% 38.98% 35.17% 30.60% 25.61%
Debt-Equity Ratio 99.13% 75.37% 63.88% 54.24% 44.08% 34.43%
Oper. Cash Flow/Tot. Liab. 24.83% 24.63% 20.94% 23.98% 29.34% 35.48%
Interest Coverage Ratio 6.1 5.93 3.85 3.96 5.75 8.05

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© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
 Chapter 10
Forecasting Financial Statements

Exhibit 10.P
Massachusetts Stove Company
Projected Income Statements under Worst-Case Scenario
(Case 10.2)

MASS. STOVE Year 7 Year 8 Year 9 Year 10 Year 11 Year 12

Income Statement Actual Projected Projected Projected Projected Projected
Sales:
Woodstoves 2,734,986 2,625,587 2,520,563 2,419,741 2,322,951 2,230,033
Gas Stoves — — 52,512 153,334 250,124 343,042
Total Sales 2,734,986 2,625,587 2,573,075 2,573,075 2,573,075 2,573,075
Cost of Good Sold (1,380,820) (1,312,793) (1,286,537) (1,286,537) (1,286,537) (1,286,537)
Depreciation (72,321) (75,654) (112,654) (149,654) (153,821) (157,988)
Facilities Income 41,004 41,004 20,502 20,502 20,502 20,502
Facilities Costs (45,309) (45,309) (75,309) (75,309) (75,309) (75,309)
Selling Expenses (926,175) (892,699) (900,576) (926,307) (952,038) (977,768)
Administrative Expenses (111,199) (141,199) (171,199) (191,199) (191,199) (191,199)
Operating Income 240,166 198,936 47,301 (35,430) (65,327) (95,225)
Interest Income 16,665
Interest Expense (42,108) (38,135) (36,223) (34,163) (31,943) (29,546)
Net Income before Tax 214,723 160,800 11,078 (69,593) (97,270) (124,770)
Income Tax Expense (60,122) (45,024) (3,102) 19,486 27,236 34,936
Net Income (Prelim.) 154,601 115,776 7,976 (50,107) (70,034) (89,835)
Interest Income (Net) 12,487 10,820 10,205 11,718 12,679
Net Income (Final) 128,263 18,796 (39,902) (58,316) (77,156)

ASSUMPTIONS
Sales Growth:
Woodstoves (0.04) (0.04) (0.04) (0.04) (0.04)
Gas Stoves 0 0.02 0.04 0.04 0.04
Total Sales (0.04) (0.02) 0 0 0
Cost of Goods Sold/Sales 0.5 0.5 0.5 0.5 0.5
Developmental Costs 160,000 160,000 — — —
Depre. of Devel. Costs — 32,000 64,000 64,000 64,000
Capital Expenditures 20,000 30,000 30,000 25,000 25,000
Additional Depreciation 3,333 8,333 13,333 17,500 21,667
Facilities Income Dec. 0 (0.5) (0.5) (0.5) (0.5)
Facilities Costs Inc. 0 30,000 30,000 30,000 30,000
Selling Exp./Sales 0.34 0.35 0.36 0.37 0.38
Administrative Exp. Inc. 30,000 30,000 20,000 — —
Interest Income 0.05 0.05 0.05 0.05 0.05
Interest Rate on Debt 0.068 0.068 0.068 0.068 0.068
Income Tax Rate 0.28 0.28 0.28 0.28 0.28

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© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Chapter 10
Forecasting Financial Statements

Exhibit 10.Q
Massachusetts Stove Company
Projected Balance Sheets under Worst-Case Scenario
(Case 10.2)

MASS. STOVE Year 7 Year 8 Year 9 Year 10 Year 11 Year 12

Balance Sheet Actual Projected Projected Projected Projected Projected
Assets
Cash 351,588 354,615 269,816 318,168 354,773 374,005
Accounts Receivable 5,997 5,757 5,642 5,642 5,642 5,642
Inventories 452,709 434,601 425,909 425,909 425,909 425,909
Total Current Assets 810,294 794,973 701,366 749,719 786,324 805,556
Fixed Assets:
Cost 1,257,673 1,437,673 1,627,673 1,657,673 1,682,673 1,707,673
Accumulated Depre. (630,125) (705,779) (818,434) (968,088) (1,121,909) (1,279,897)
Net 627,548 731,894 809,239 689,585 560,764 427,776
Total Assets 1,437,842 1,526,867 1,510,605 1,439,304 1,347,088 1,233,332
Liabilities and Sh. Eq.
Accounts Payable 47,809 45,897 44,979 44,979 44,979 44,979
Cur. Portion—L.T. Debt 27,036 29,200 31,400 33,900 36,600 39,500
Other Current Liabilities 257,252 246,962 242,023 242,023 242,023 242,023
Total Current Liabilities 332,097 322,059 318,401 320,901 323,601 326,501
Long-Term Debt 547,296 518,096 486,696 452,796 416,196 376,696
Deferred Income Taxes 6,369 6,369 6,369 6,369 6,369 6,369
Total Liabilities 885,762 846,524 811,466 780,066 746,166 709,566
Common Stock 2,000 2,000 2,000 2,000 2,000 2,000
Additional Paid-In Cap. 435,630 435,630 435,630 435,630 435,630 435,630
Retained Earnings 189,450 317,713 336,509 296,608 238,291 161,136
Treasury Stock (75,000) (75,000) (75,000) (75,000) (75,000) (75,000)
Total Share. Equity 552,080 680,343 699,139 659,238 600,921 523,766
Total Liab. and Sh. Eq. 1,437,842 1,526,867 1,510,605 1,439,304 1,347,088 1,233,332
ASSUMPTIONS
Cash Statement of Cash Flows
Accounts Receivable Growth Rate of Sales
Inventories Growth Rate of Cost of Goods Sold
Fixed Assets at Cost Growth Equal to Devel. Cost Plus Cap. Expend.
Accumulated Depre. Amort. of Develop. Costs and Cap. Expend.
Accounts Payable Growth Rate of Inventories
Cur. Portion—L.T. Debt Given in Case
Other Current Liabilities Growth Rate of Sales
Long-Term Debt Reduced by Current Portion of Debt
Deferred Income Taxes No Change
Contributed Capital No Change

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© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
 Chapter 10
Forecasting Financial Statements

Exhibit 10.R
Massachusetts Stove Company
Projected Statements of Cash Flows under Worst-Case Scenario
(Case 10.2)

MASS. STOVE Year 7 Year 8 Year 9 Year 10 Year 11 Year 12

State. of Cash Flows Actual Projected Projected Projected Projected Projected
Operations
Net Income (Prelim.) 154,601 115,776 7,976 (50,107) (70,034) (89,835)
Depreciation 72,321 75,654 112,654 149,654 153,821 157,988
Deferred Taxes 909 0 0 0 0 0
Change in Acct. Rec. 24,992 240 115 — — —
Change in Inventories (43,036) 18,108 8,692 — — —
Change in Acct. Pay. 8,639 (1,912) (918) — — —
Change in Ot.Cur.Liab. 13,011 (10,290) (4,939) — — —
Cash Flow from Oper. 231,437 197,576 123,580 99,548 83,787 68,153
Investing
Capital Expenditures (22,921) (180,000) (190,000) (30,000) (25,000) (25,000)
Cash Flow from Invest. (22,921) (180,000) (190,000) (30,000) (25,000) (25,000)
Financing
Repayment of L.T. Debt (115,076) (27,036) (29,200) (31,400) (33,900) (36,600)
Cash Flow from Fin. (115,076) (27,036) (29,200) (31,400) (33,900) (36,600)
Net Change in Cash 93,440 (9,460) (95,620) 38,148 24,887 6,553
Cash—Beg. of Year 258,148 351,588 354,615 269,816 318,168 354,773
Cash—End of Yr (Prelim.) 351,588 342,128 258,995 307,963 343,055 361,326
Interest Income 17,343 15,028 14,174 16,275 17,610
Inc. Taxes on Int. Inc. (4,856) (4,208) (3,969) (4,557) (4,931)
Cash Flow from Int. Inc. 12,487 10,820 10,205 11,718 12,679
Cash—End of Year (Final) 354,615 269,816 318,168 354,773 374,005

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© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Chapter 10
Forecasting Financial Statements

Exhibit 10.S
Massachusetts Stove Company
Projected Financial Statement Ratios under Worst-Case Scenario
(Case 10.2)

MASS. STOVE Year 7 Year 8 Year 9 Year 10 Year 11 Year 12

Financial Ratios Actual Projected Projected Projected Projected Projected
Profit Margin for ROA 6.76% 5.93% 1.74% (0.59%) (1.37%) (2.17%)
Assets Turnover 1.94 1.77 1.69 1.74 1.85 1.99
Return on Assets 13.14% 10.50% 2.95% (1.04%) (2.53%) (4.33%)
Profit Margin for ROCE 5.65% 4.89% 0.73% (1.55%) (2.27%) (3.00%)
Capital Structure Lev. 2.96 2.41 2.20 2.17 2.21 2.29
Return on Share. Equity 32.56% 20.81% 2.73% (5.87%) (9.26%) (13.72%)
Cost of Goods Sold/Sales 50.48% 50.00% 50.00% 50.00% 50.00% 50.00%
Depreciation/Sales 2.64% 2.88% 4.38% 5.82% 5.98% 6.14%
Selling Expense/Sales 33.86% 34.00% 35.00% 36.00% 37.00% 38.00%
Admin. Expense/Sales 4.07% 5.38% 6.65% 7.43% 7.43% 7.43%
Interest Income/Sales 1.54% 1.45% 1.41% 1.33% 1.24% 1.15%
Inc.Tax Expense/Sales 2.20% 1.90% 0.28% (0.60%) (0.88%) (1.17%)
Accounts Rec. Turnover 147.89 446.75 451.45 456.06 456.06 456.06
Inventory Turnover 3.2 2.96 2.99 3.02 3.02 3.02
Fixed-Asset Turnover 4.19 3.86 3.34 3.43 4.12 5.21
Current Ratio 2.44 2.47 2.20 2.34 2.43 2.47
Quick Ratio 1.08 1.12 0.87 1.01 1.11 1.16
Days Accounts Payable 11.15 13.21 12.98 12.76 12.76 12.76
Oper. Cash Flow/Cur. Liab. 63.36% 64.22% 41.97% 34.34% 29.64% 24.87%
Long-Term Debt Ratio 49.78% 43.23% 41.04% 40.72% 40.92% 41.83%
Debt-Equity Ratio 99.13% 76.15% 69.61% 68.68% 69.26% 71.92%
Oper. Cash Flow/Tot. Liab. 24.83% 24.25% 16.21% 13.79% 12.52% 11.11%
Interest Coverage Ratio 6.1 5.67 1.72 (0.62) (1.54) (2.63)

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© 2018 Cengage Learning®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.