Unit 3 Financial Planning and Forecasting
Overview
Managers and investors need to understand how to forecast future results. Managers use pro
forma, or projected, statements and use them in four ways. First, by looking at projected
statements, managers can assess whether the firm’s anticipated performance is inline with the
firm’s internal targets and with investors’ expectations. Second, pro forma statements can be
used to estimate the impact of proposed operating changes. Third, managers use pro forma
statement to anticipate the firm’s future financial needs, and then arrange the necessary
financings. Finally, projected financial statements are used to estimate free cash flows, which
determine the firm’s overall financial value. Managers forecast their capital requirements, and
then choose the plan that maximizes shareholder value. Security analysts make the same type
of projections as managers, and influence the investors, who determine the future of
managers.
In this chapter we explain how to create and use pro forma statements, beginning with
the strategic plan, the foundation for pro forma statements. We focus on three key elements of
the financial plan: (1) the sale forecast,
(2) pro forma financial statements, and (3) the
external financial plan.
Outline
Value creation is impossible unless a company has a well-articulated plan. Most companies
have a mission statement, a condensed version of a firm’s strategic plan.
Strategic plan and mission statements usually begin with a statement of the overall
corporate purpose.
The corporate scope defines a firm’s lines of business and geographic area of operations.
Corporate objectives set forth specific goals for management to attain, which can be
specify both in qualitative and quantitative terms.
Most companies have multiple objectives, and revise theses as business conditions
□.
changes.
Once a firm has defined its purposes, scope, and objectives, it should develop a strategy
for achieving its goals.
□.
Corporate strategies are broad approaches rather than detailed plans.
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□. Corporate strategies should be both attainable and compatible with the firm’s
purposes, scope, and objectives.
Operating plans can be developed for any time horizon, but most companies use a five year
horizon. The plan is intended to provide detailed implementation guidance, based on the
corporate strategy, to help meet the corporate objectives. It explains in considerable detail
who is responsible for a particular function, when specific tasks are to be accomplished, sales
and profit targets, and the like.
Large multidivisional companies break down their operating plans by division. Each
division has its own goals, mission, and plan for meeting its objectives, and theses plans are
then consolidated to form the corporate plan.
The financial planning process can be broken down into six steps: (1) Development of
projected financial statements, (2) determination of the funds needed to support the five
year plan, (3) forecast of funds availability over the next five years, (4) establishment and
maintenance of a system of controls governing the allocation and use of funds within the firm,
(5) development of procedures to adjust for adjusting the basic plan, and (6) establishment of
a performance-based management compensation system.
Although the type of financial forecasting described in this chapter can be done with a hand
calculator, virtually all corporate forecasts are made using computerized forecasting models.
Spreadsheets have two major advantages over pencil-and –paper calculations.
□. It is much faster to construct a spreadsheet model than to make a “by-hand” forecast
if the forecast period extends beyond a year or two.
□. A spreadsheet model can recalculate the projected financial statements and ratios
almost instantaneously when one of the input variables is changed, thus making it easy for
managers to determine the effects of changes in variables such as sales.
The sales forecast generally begins with a review of sales during the past five to ten years.
The sales forecast is a forecast of a firm’s units and dollar sales for some future period,
and is generally based on recent sales trends plus forecasts of the economic prospects for the
nation, region, industry and so on.
If the sales forecast is off, the consequences can be serious. Thus, an accurate sales
forecast is critical to the firm’s well being.
Once sales have been forecasted, future balance sheets and income statements must be
forecast. The most commonly used technique is the percent of sales method, which begins
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with the sales forecast, expressed as an annual growth rate in dollar sales revenue.
The percent of sales method is a method of forecasting future financial statements that
expresses each account as a percentage of sales. These percentages can be constant or they
can change overtime.
□. The period in which the forecasted sales hold is called the explicit forecast period,
with the last year being the forecast horizon.
□. Population growth and inflation determine the long-term growth rate for most
companies.
□. Companies often have a competitive advantage period, during which they can grow at
rates higher than the long-term growth rate.
□. Many items on the income statement and balance sheet are often assumed to increase
proporti0nately with sales. Items are not tied directly to sales depend on the company’s
policies and the managers’ decisions.
The constant ratio method of forecasting is a forecasting approach in which the
forecasted percentage sales for each item is the same as the actual percentage for the year
preceding the forecast period.
The first step in using the percent of sales method is to forecast the next year’s income
statement to estimate income and the addition to retained earnings.
□. A sales forecast is needed.
□. The percent of sales method assumes initially that all costs except depreciation are a
specified percentage of sales.
□. In the simplest case, costs are assumed to increase at the same rate as sales; in more
complicated situations, specific casts are forecasted separately.
□. Interest and preferred dividend amounts are simply prior year amounts carried over to
the forecast period. These amounts are changed when external financing requirements are
analyzed in a later step.
The second step is to forecast next year’s balance sheet.
□. All asset accounts can be assumed to increase directly as percentage of sales unless
the firm is operating at less than full capacity. If the firm is not operating at full capacity, then
fixed assets will not vary with directly sales, but the cash, receivable, and inventory accounts
will increase as a percentage of sales.
□. Liabilities, equity, or both must also increase if assets increase---assets expansions
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must be financed in some manner.
□. Certain liability accounts, such as accounts payable and accruals, can be expected to
increase spontaneously with sales. These are spontaneously generated funds, obtained
automatically from routine business transactions.
□. Retained earnings will increase, but not proportionally with sales. The new retained
earnings will be determined from the projected income statement.
□. Other financial accounts, such as short-term debt, long-term debt, preferred stock, and
common stock, are not directly related to sales. Changes in theses accounts result from
managerial financing decisions; they do not increase spontaneously as sales increase.
□. The difference between projected total assets and projected liabilities and capital is
the amount of additional funds needed (AFN). AFN are funds that a firm must raise
externally through borrowing or by selling new common or preferred stock.
The third step is the decision on how to finance the additional funds required.
Sometimes contractual agreements, such as a limit on the debt ratio, will restrict the firm’s
financing decisions. Other factors that the financial staff must consider are3 the firm’s target
capital structure, the effect of short-term borrowing on its current ratio, and conditions in the
debt and equity market.
One complexity arises in financial forecasting relates to financing feedbacks, which are
the effects on the income statement and balance sheet of actions taken to finance asset
increases. In view of the fact that all of the data are based on forecasts, and since the
adjustments add substantially to the work but relatively little to the accuracy of the forecast,
we leave them to later finance courses.
Once the pro forma financial statements have been developed, the key ratios can be
analyzed to determine whether the forecast meets the firm’s financial targets as set forth in its
financial plan. If the statements do not meet the target, then elements of the forecast must be
changed.
□. A spreadsheet model can e run using different sales growth rates, with the results
analyzed to see how the ratios would change under different growth scenarios
□. A spreadsheet model can also be used to evaluate dividend policy, financing
alternatives, and alternative working capital policies.
Forecasting is an iterative process, both in the way the financial statements are generated
and the way the financial plan I developed.
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□. For planning purposes, the financial staff develops a preliminary forecast based on a
continuation of past policies and trends. This provides a starting point, or “baseline” forecast.
□. Projections are modified to see what effects alternative operating plans would have
on the firm’s earnings and financial conditions. This results in a revised forecast.
□. Alternative operating plans are examined under different sales growth scenarios, and
the model is used to evaluate both dividend policy and capital structure decisions.
Free cash flow is calculated as follows:
FCF = Operating cash flow — Gross investment in operating capital
Alternatively, free cash flow can be calculated as :
FCF = NOPAT —Net investment in operating capital.
□. Free cash flow represents the amounts of cash generated in a given year minus the
amount of cash needed to finance the additional capital expenditures and working cpital
needed to support the firm’s growth.
□. Forecasts of free cash flows are used by investors and financial managers to estimate
the firm’s stock price.
Although forecasts of capital requirements are always made by constructing pro forma
financial statements as described above, if the ratios are expected to remain constant an
approximation can be obtained by using a simple forecasting formula.
The formula is as follows:
Additional funds needs
= Required increase in assets — Spontaneous increase in liabilities — Increase in retained earning
Or
AFN = (A*/S0)△S — (L*/S0)△S — MS1(RR)
□. A*/S0 = assets that must increase if sales are to increase, assets that are tied directly to
sales.
□. L*/S0 = liabilities that increase spontaneously as percentage of sales, or spontaneously
generated financing per $1 increase3 in sales.
□. S1 = total expected sales for the year in question. S0 = last year’s sales.
□. △S = change in sales = S1 — S0.
□. M = profit margin, or profit per $1 of sales.
□. RR is the retention ratio, which is the percentage of net income that is retained.
• RR is also equal to 1—payout ratio.
• the retention ratio and payout ratio must total to 100%.
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The equation shows that external financing requirements depend on five factors:
□. Rapidly growing companies require large increase in assets, other things held
constant, so sales growth is an important factor.
□. The amount of assets required per dollar of sales, or capital intensity ratio, has a
major effect on capital requirements. Companies with a high ratio of assets-to-sales ratios
require more assets for a given increase in sales, hence a greater need for external financing.
□. Companies that spontaneously generate a large amount of liabilities from account
payable and accruals will have a relatively small need for external financing.
□. The higher the profit margin, the larger net income available to support the increases
in assets, hence the low need for external financing.
□. Companies that retain more of their earnings as opposed to paying them out as
dividends will generate more retained earnings and hence have less need for external
financing.
The AFN formula provides an accurate forecast only for companies whose ratios are all
expected remain constant, and may be used to provide a quick estimate of external financing
requirements. But in planning process the actual additional funds needed should be calculated
by projected financial statements.
Both the AFN formula and the projected financial statement method assume that the ratios of
assets and liabilities to sales remain constant over time. This, in turn, requires the assumption
that each “spontaneous” asset and liability item increases at the same rate as sales. The
assumption of constant ratios and identical growth rates in appropriate at times, but there are
times when it is incorrect.
Where economies of scale occur in asset use, the ratio of that asset to sales will change
as the size of the firm increases.
Technological considerations sometimes dictate that fixed assets be added in large,
discrete units, often referred to as lumpy assets. This automatically creates excess capacity
immediately after a plant expansion.
Forecast errors can cause the actual assets/sales ratio for a given period to be quite
different from the planned ratio, resulting in excess capacity.
If any of the above conditions apply (economies of scales, lumpy assets, or excess capacity),
the A*/S0 ratio will not be constant, and the constant growth forecasting methods should not
be used. Rather techniques must be used to forecast asset levels to determine additional
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financing requirements. Two of these methods include linear regression and excess capacity
adjustment.
If one assumes that the relationship between a certain type of asset and sales is linear,
then one can use simple linear regression techniques to estimate the requirements for that
type of assets for any given sales increase. An estimated regression equation is determined
that provides an estimated relationship between a given asset account and sales.
If a firm’s fixed assets are not operating at full capacity, then the calculation for required
level of fixed assets will need to be adjusted.
□. Full capacity sales are actual sales divided by the percentage of capacity at which the
fixed assets were operated to achieve these sales:
FullCapacityScale 
ActualSales
PercentageOfCapacityOperated
□. The target fixed assets to sales ratio is equal to the current year’s fixed assets divided
by full capacity sales:
T arg etFixedAssetToSalesRatio 
ActualFixedAssets
FullCapacitySales
□. The required level of fixed assets is equal to the target fixed assets to sales ratio times
projected sales:
Required level of fixed assets = (Target fixed assets to sales ratio)(Projected dales)
Question
1. Those asset items that typically increase proportionally with higher sales are _______ ,
______, and _______. ________ assets are frequently not used to full capacity, when that
occurs, do not increase as percentage of sales.
2. Short-term and long-term _______, _______ stock, ________ stock, and ________
earnings are examples of accounts that do not increase proportionately with higher level
of sales.
3. The amount of assets that are tied directly to sales, A*/S0, is often called the _______
________ ratio.
4. The _______ _____ _______ method involves projecting the asset requirements for the
coming period, then projecting the liabilities and equity will be generated under normal
operations, and subtracting the projected liabilities and capital from the required assets to
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estimate the _________ _______ _______.
5. _______ _______ ________ is defined as actual sales divided by the percentage of
capacity at which fixed assets were to operated to achieve those sales.
6. If the capital intensity ratio of a firm actually decreases as sales increase, use of formula
method will typically overstate the amount of additional funds required, other thing held
constant.
a. True
b. False
7. Which of the following would reduce the additional funds required if all other things held
constant?
a. An increase in the dividend payout ratio.
b. A decrease in the profit margin.
c. An increase in the capital intensity ratio.
d. An increase in the expected sales growth rate.
e. A decrease in the firm’s tax rate.
8. Which of the following statements is most correct?
a. Suppose economies of scale exist in a firm’s use of assets. Under this condition, the
firm should use regression method of forecasting asset requirements rather than the
percent of sale method.
b. If a firm must acquire assets in lumpy units, it can avoid errors in forecasts of its
need for funds by using the linear regression method of forecasting asset
requirements because all the points will lie on the regression line.
c. If the economies of scale in the use of assets exist, then the AFN formula rather than
the percent of sales method should be used to forecast additional funds requirements.
d. Notes payable to banks are included in the AFN formula, along with a projection of
retained earnings.
e. One problem with AFN formula is that it does not take account of the firm’s dividend
policy.
Questions
1. United Products Inc.’s business has been slow; therefore, fixed assets are vastly
underutilized. Management believes it can double sales nest year with the introduction of
a new product. No new fixed assets will be required, and management expected that there
will be no earnings retained next year. Under the following conditions, what is the next
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year’s additional financing requirement?
Current assets
$5,000
Accounts payable
$1,000
Notes payable
1,000
5,000
Long-term debt
4,000
_______
Common equity
4,000
Net fixed assets
Total assets
a. $0
$10,000
b. $4,000
Total liabilities and equity $10,000
c. $6,000
d. $13,000
e. $19,000
2. The 2000 balance sheet for American Pulp and Paper is shown below (in million dollars)
Cash
$ 3.0
Account receivable
3.0
Inventory
5.0
Accounts payable
Notes payable
Total current assets $11.0
Fixed assets
Total assets
$ 2.0
1.5
Total current liabilities
$ 3.5
3.0
Long-term debt
3.0
______
Common equity
7.5
$ 14.0
Total liabilities and equity
$
14.0
In 2000, sales were $60 million. In 2001 management believes that sales will increase 20
percent to the total of $72 million. The profit margin is expected to 5 percent, and the
dividend payout ratio is targeted at 40%. No excess capacity exists. What is the additional
funds needed (in millions) for 2001 using the formula method?
3. Refer to Problem 2, how much can sales grow above the 2000 level of sales of $60
million without requiring any additional funds?
a. 12.28%
b. 14.63%
c. 15.75%
d. 17.65%
e. 18.45%
4. Smith Machines Inc. has a net income this year of $500 on sales of $2,000 and is
operating its fixed assets at full capacity. Management expects sales to increase at 25
percent nest year and is forecast a dividend payout ratio of 30 percent. The profit margin
is not expected to change. If spontaneous liabilities are $500 this year and no excess funds
are expected next year, what are Smith’s total assets this year?
a. $1,000
b. $1,500
c. $2,250
d. $3,000
e. $3,250
(The following data apply to the next three problems)
Crossley Products Company
Balance Sheet as of December 31, 2000
(Thousands of dollars)
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Cash
$
600
Accounts payable
Receivable
3,600
Notes payable
Inventory
4,200
Accruals
Total current assets
$
8,400
Net fixed assets
1,157
840
Total current liabilities
$ 4,397
Mortgage bonds
1,667
Common stock
667
7,200
Total assets
$ 2,400
Retained earnings
$ 15,600
8,869
Total liabilities and equity
$ 15,600
Crossley Products Company
Income Statements for December 31, 2000
(Thousands of dollars)
Sales
$12,000
Operating costs
10,261
Earnings
$ 1,739
Interest
339
Earnings before taxes
$ 1,400
Taxes (40%)
560
Net income
$ 840
Dividends (60%)
$ 504
Additional retained earnings
$ 336
5. Assume that the company was operating at full capacity in 2000 with regard to all items
except fixed assets; fixed assets in 2000 were utilized to only 75 percent of capacity. By
what percentage could 2001 sales increase over 2000 sales without the need for an
increase in fixed assets?
a. 33%
b. 25%
c. 20%
d. 44%
e. 50%
6. Now suppose 2001 sales increase by 25 percent over 2000 sales. Assume that Crossley
cannot see any fixed assets. Use the percent of sales method to develop a pro forma
balance sheet and income statement. Assume that any required financing is borrowed as
notes payable. Use a pro forma income statement to determine the additional external
capital (in thousands) will be required.
a. $825
b. $925
c. $750
d. $900
e. $850
7. Refer to problem 6. After the required financing is borrowed as notes payable, what is is
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the firm’s current and debt ratio?
a. 1.73; 38.84%
b. 2.02; 38.84%
c. 1.73; 44.06%
d. 1.73; 43.64%
e. 2.02; 44.06%
(The following data apply to the next two problems)
Taylor Technologies Inc.
Balance Sheet as of December 31,2000
Cash
$
90,000
Accounts payable
$
180,000
Receivables
180,000
Notes payable
78,000
Inventory
360,000
Accruals
90,000
Total CA
$ 630,000
Net fixed assets
720,000
Total assets
$ 1,350,000
Total CL
$
348,000
Common stock
900,000
Retained earnings
102,000
Total L$E
$ 1.350,000
Taylor Technologies Inc.
Income Statement for December 31,2000
Sales $
$1,800,000
Operation costs
1,639,860
EBIT $
$ 160,140
Interest
10,140
EBT $
$ 150,000
Taxes (40%)
60,000
Net income $
$
90,000
Dividends (60%)
$
54000
Addition to retained earnings $
36,000
8. Suppose that in 2001,sales increase by 10 percent over 2000 sales. Construct the pro
forma financial statements using the percent sales method. Assume the firm operated at
full capacity in 2000. how much additional capital will be required?
a. $72,459
b. $70,211
c. $68,157
d. $66,445
e. $63,989
9. Refer to problem 8. Assume now that fixed assets are only being operated at 95 percent of
capacity. Construct the pro forma financial statements using the percent of sales method.
How much additional capital will be required?
a. $28,557
b. $32,400
c. $39,843
d. $45,400 e. $50,000
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10.
Answers for questions (Financial Planning and Forecast)
1. cash; receivable; inventory; Fixed
2. debt; preferred; common; retained
3. capital intensity
4. percent of sales; additional funds needed
5. Full capacity sales
6. a. A decreasing capital intensity ratio, A*/S0, means that fewer assets are required,
proportionately, as sales increase. Thus, the external funding requirement is overstated.
Always keep in mind that the formula method assumes that the asset/sales ratio is
constant regardless of the level of sales.
7. e. Answer a through d would increase the additional funds required, but an decrease in the
tax rate would raise the profit margin and thus increase the amount of available retained
earnings.
8. a. Statement a is correct; economies of scale cause the ratios to change over time, which
violates the assumption of the percent of scales method. Statement b is false; the points
will not all lie on the regression line. Statement c is false; the AFN formula requires
percentage of sales over time. Statement d is false; the AFN formula includes only
spontaneous liabilities, and notes payable do not spontaneously increase with sales.
Statement e is false; the AFN formula includes the dividend payout, so dividend policy is
included.
Answers for problems (Financial Planning and Forecast)
1. b. Look at next year’s balance sheet:
Current assets
$10,000
Accounts payable
Notes payable
Current liabilities
Net fixed assets
$2,000
1,000
$3,000
5,000
Long-term debt
4,000
_______
Common equity
4,000
$11,000
AFN
Total assets
$15,000
4,000
Total liabilities and equity
$15,000
With no retained earning next year, the common equity account remains at $4,000. thus, the
additional financing requirement is $15,000 - $1,000 = $4,000.
2. b. None of the items on the right side of the balance sheet rises spontaneously with sales
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except account payable. Therefore,
AFN = (A*/S0)△S — (L*/S0)△S — MS1(RR)
= ($14/$60)($12) — ($2/$60)($12) — (0.05)($72)(0.6)
= $2.8 — $0.4 — $2.16 = $0.24 million.
3. d. Note that g = Sales growth = △S/S0 and S1 = S0 (1+g). Then,
AFN = A*g — L*g — M[(S0) (1+g)](RR) = 0, $14g — $2g — 0.05[60 (1+g)](0.60) = 0
g = 0.1765 = 17.65%.
4. c. 0 = (A*/S0)△S — (L*/S0)△S — MS1(RR)
0 = (A*/2,000)(2,000×0.25) — (500/2,000) (500) — (500/2,000) (2,500×0.7)
0 = (500A*/2,000) — 125 — 437.5
5. a.
FullCapaci tySales 
PercentIncrease 
A* = $2,250
12,000
 16,000
0.75
16,000  12,000
 0.33  33%
12,000
6. e.
Cross Products Company
Pro Forma Income Statement
December 31,2001
(Thousands of dollars)
___2000
Sales
Operating costs
EBIT
Interest
EBT
$12,000
Forecast
2001
Basisa
Forecast
1.25
$15,000
__ 10,261
12,826
$ 1,739
$ 2,174
339
339
$ 1,400
$ 1,835
560
_____734
Net income
$ 840
$ 1,101
Dividends (60%)
$ 504
$ 601
Additional to RE
$ 336
$ 440
Taxes (40%)
Cross Products Company
Pro Forma Balance Sheet
13
December 31,2001
(Thousands of dollars)
2000
Cash
$
600
Forecast
2001
Basisa
Forecast
1.25
$
2002 After
AFN
750
AFN
$
750
Receivables
3,600
4,500
4,500
Inventory
4,200
5,250
5,250
$ 8,400
$ 10,500
$ 10,500
Total CA
7,200b
$ 7,200
$15,600
$17,700
$ 17,700
Accts. Payable $ 2,400
$ 3,000
$ 3,000
Net fixed assets $ 7,200
Total assets
Notes payable
1,157
Accruals
1,157
+850
2,007
840
$ 1,050
1,050
$ 4,397
$5,207
$ 6,057
Mortgage Bon.
1,667
1,667
1,667
Common Sto.
667
667
667
9,309
9,309
Total CL
RE
440c
8,869
Total L&E
$15,600
$ 16,850
$ 17,700
AFN = $ 850
Notes:
a
Sales are increased by 25%. Operating costs, all assets except fixed assets, accruals,
and accounts payable are adjusted to determine the appropriate ratios to apply to 2001 sales to
calculate 2001 account balances.
b
From problem 5 we know that sales can increase by 33% before additions to fixed
assets are needed.
c
See income statement.
7. d. Current ratio = CA/CL = 10,500/6,057 =1,73.
Debt / Asset 
6,057  1,667
 43.64%
17,700
8. c. The projected balance sheet indicated that the AFN = $68157
Taylor Technologies Inc.
Pro Forma Income Statement
14
December 31, 2001
Sales
Forecast
2001
2000
Basisa
Forecst
$1,800,000
1.10
Operating costs
EBIT
1,639860
$1,980,000
0.9110
1,803,846
$ 160,140
$ 176,154
10,140
10,140
$ 150,000
$ 166,014
60,000
66,406
Net income
$ 90,000
99,608
Dividends (60%)
$ 54,000
$
59,765
Addition to RE
$ 36,000
$
39,843
Interest
EBT
Taxes (40%)
Taylor Technologies Inc.
Pro Forma Balance Sheet
December 31, 2001
Forecast
2001
2000
Basisa
Forecast
90,000
0.05
Receivables
180,000
0.10
198,000
Inventory
360,000
0.20
396,000
Cash
Total current assets
$
$
Fixed assets
Total assets
Accounts payable
630,000
Accruals
90,000
$
0.10
$
900,000
Retained earnings
102,000
198,000
78,000
0.05
99,000
348,000
Common stock
Total L&E
792,000
$ 1,485,000
180,000
78,000
693,000
0.40
$ 1,350,000
$
99,000
$
720,000
Notes payable
Total CL
$
$
375,000
900,000
39,843b
$ 1,350,000
141,483
$ 1,416,843
AFN = $
Notes:
15
68,157
a
Sales are increase by 10 %. Operating costs, all assets, accruals, and accounts payable
are divided by 2000 sales to determine the appropriate ratios to apply to 2001 sales to
calculate 2001 account balances.
b
See income statement.
9. a. The projected balance sheet indicates that the AFN = $28,557
(The Pro Forma Income Statement is just the same as that constructed in problem 8.)
Taylor Technologies Inc.
Pro Forma Balance Sheet
December 31, 2001
Forecast
2001
2000
Basisa
Forecast
90,000
0.05
Receivables
180,000
0.10
198,000
Inventory
360,000
0.20
396,000
Cash
Total current assets
$
$
Fixed assets
Total assets
Accounts payable
630,000
Accruals
90,000
$
0.10
$
900,000
Retained earnings
102,000
198,000
78,000
0.05
99,000
348,000
Common stock
Total L&E
752,400
$ 1,445,400
180,000
78,000
693,000
32,400b
$ 1,350,000
$
99,000
$
720,000
Notes payable
Total CL
$
$
375,000
900,000
39,843c
141,483
$ 1,350,000
$ 1,416,843
AFN = $
b
Full Capacity Sales = 1,800,000/0.95= 1,897,737
Target fixed assets/Sales ratio = 720,000 /1,894,737 = 38%
Required level of fixed assets = (0.38) (1,980,000) = 752,400
Necessary FA increase = 752,400 — 720,000 =32,400.
c
See income statement.
16
28,557