Chapter 9.

Ch 09-10 Build a Model

Cumberland Industries' financial planners must forecast the company's financial results for the coming year. The forecast
for many items will be based on sales, and any additional funds needed will be obtained as notes payable.

a. Assuming the historical trend continues, what will sales be in 2010? Base your forecast on a spreadsheet regression
analysis of the 2004-2009 sales data above, and include the summary output of the regression in your answer. By what
percentage are sales predicted to increase in 2010 over 2009? Is the sales growth rate increasing or decreasing?

Here are the company's historical sales. Hint: Use the Trend function to forecast sales for 2010.

Year Sales Growth Rate

2004 129,215,000
2005 180,901,000 40.0%
2006 235,252,000 42.1%
2007 294,065,000 25.0%
2008 396,692,000 34.9%
2009 455,150,000 14.7%
2010 515,465,267 13.25%

% Increase in Predicted Sales for 2010 over 2009:

2009 Sales 455,150,000

2010 Sales 515,465,267

% increase 13.25% Note: This growth rate has been declining over time.

b. Cumberland’s management believes that the firm will actually experience a 20 percent increase in sales during 2010.
Construct 2010 pro forma financial statements. Cumberland will not issue any new stock or long-term bonds. Assume
Cumberland will carry forward its current amounts of short-term investments and notes payable, prior to calculating AFN.
Assume that any Additional Funds Needed (AFN) will be raised as notes payable (if AFN is negative, Cumberland will
purchase additional short-term investments). Use an interest rate of 9 percent for short-term debt (and for the interest
income on short-term investments) and a rate of 11 percent for long-term debt. No interest is earned on cash. Use the
beginning of year debt balances to calculate net interest expense. Assume that dividends grow at an 8 percent rate.

Key Input Data: Used in the

forecast
Tax rate 40%
Dividend growth rate 8%
S-T rd 9%
L-T rd 11%
growth sales 20%
December 31 Income Statements:
(in thousands of dollars)
Forecasting 2009 2010 2010
 2009 basis Ratios Inputs Forecast
Sales $455,150 Growth 20.00% $477,908
Expenses (excluding depr. & amort.) $386,878 % of sales 85.00% 85.00% $406,221
EBITDA $68,273 $71,686
Depreciation and Amortization $7,388 % of fixed assets 11.00% 11.00% $7,757
EBIT $60,885 $63,929
Net Interest Expense $8,575 Interest rate x beginning of year debt $8,868
EBT $52,310 $55,061
Taxes (40%) $20,924 $22,024
Net Income $31,386 $33,037
Common dividends $12,554 Growth 8.00% $13,558
Addition to retained earnings (∆RE) $18,832 $19,478

Cumberland Industries December 31 Balance Sheets

(in thousands of dollars)
Forecasting 2009 2010 2010
2009 basis Ratios Inputs Without AFN AFN
Assets:
Cash and cash equivalents $91,450 % of sales 20.092% 20.092% $96,023
Short-term investments $11,400 Previous $11,400 $0
Accounts Receivable $103,365 % of sales 22.710% 22.710% $108,533
Inventories $38,444 % of sales 8.446% 8.446% $40,366
Total current assets $244,659 $256,322
Fixed assets $67,165 % of sales 14.757% 14.757% $70,523
Total assets $311,824 $326,845

Liabilities and equity

Accounts payable $30,761 % of sales $32,299
Accruals $30,477 % of sales $32,001
Notes payable $16,717 Previous $16,717 -$7,519
Total current liabilities $77,955 $81,017
Long-term debt $76,264 Previous $76,264
Total liabilities $154,219 $157,281
Common stock $100,000 Previous $100,000
Retained Earnings $57,605 Previous + ∆RE $77,083
Total common equity $157,605 $177,083
Total liabilities and equity $311,824 $334,364

Required assets = $326,845

Specified sources of financing = $334,364
Additional funds needed (AFN) = -$7,519

Required additional notes payable = $22,879

Additional short-term investments = $0

c. Now create a graph depicting the sensitivity of AFN for the coming year to the sales growth rate. To make
this graph, compare the AFN at sales growth rates of 5%, 10%, 15%, 20%, 25%, and 30%.

We can use a data table to answer this question:

 Sales 2010 AFN
Growth rate -$7,519 $0
5% -$7,519 -$1,000
10% -$7,519
-$2,000
15% -$7,519
20% -$7,519 -$3,000
25% -$7,519 -$4,000 Column B
30% -$7,519
-$5,000
-$6,000
-$7,000
-$8,000
0% 5% 10% 15% 20% 25% 30% 35%

d. Calculate the Net Operating Working Capital (NOWC), Total Operating Capital, and NOPAT for 2009 and
2010. Also, calculate the FCF for 2010.

Net Operating Working Capital

NOWC09 = Operating CA - Operating CL

= $233,259 - $61,238
= $172,021

NOWC10 = Operating CA - Operating CL

= $244,922 - $64,300
= $180,622

Total Operating Capital

TOC09 = NOWC + Fixed assets

= $172,021 + $67,165
= $239,186

TOC10 = NOWC + Fixed assets

= $180,622 + $70,523
= $251,145

Net Operating Profit After Taxes

NOPAT09 = EBIT x (1-T)

= $60,885 x 60%
= $36,531

NOPAT10 = EBIT x (1-T)

= $63,929 x 60%
= $38,357

Free Cash Flow

FCF10 = NOPAT - Increase in TOC

= $38,357 - $11,959
 = $26,398

e. Suppose Cumberland can reduce its inventory to sales ratio to 5 percent and its cost to sales ratio to 83 percent. What
happens to AFN and FCF?

Input Base Case New Scenario

Inv. / Sales 8.446% 5.0% Note: we used the Scenario Manager.
Costs / Sales 85.0% 83.0%
FCF $26,398
AFN $22,879
Scenario Summary
Current Values: Base New
Changing Cells:
$G$55 85.00% 85.00% 83.00%
$F$76 8.446% 8.446% 5.000%
Result Cells:
$B$157 -$4,000 -$4,000 $21,378
$G$95 $22,879 $22,879 -$2,499
Notes: Current Values column represents values of changing cells at
time Scenario Summary Report was created. Changing cells for each
scenario are highlighted in gray.