1 Allied Food Products: Actual 2005 and projected 2006 Income Statements ($ Millions) Actual Forecast 2006 Forecast 2005 Basis 1st Pass Feedback 4th Pass Modified (1) (2) (3) (4) (5) (6) 1. Sales $3,000 x 1.10 a $3,300 $3,300 $3, Costs except deprec 2,616.2 x , , , Depreciation 100 x Total operating costs 2,716.2 $2, , , EBIT $ $ $ $ Less interest b Earnings before taxes $ $ $ $ Taxes (40%) NI available to $ $ $ $ common stockholders 10.Dividends to com. stk. $ 57.5 $ 63.3 c $ 63.3 $ Addition to retained 60 $ $ 67.5 $ 89.3 earnings

2 Allied Food Products: Actual 2005 and projected 2006 Income Statements ($ Millions) a x 1.10 indicates “times 1 + g”; used for items which grow proportionally with sales. Here g = b 2005 amount carried over for first-pass forecast. Indicated in Column 2 by an arrow. c Projected figure. See text for explanation.

3 Allied Food Products: Actual 2005 and projected 2006 Balance Sheets 2006 Forecast Actual‘05 1+ Sales g 1st Pass AFN a 4th Pass (1) (2) (3) (4) (5) Cash $ 10 x 1.10 b $ 11 $ 11 Accounts receivable 375 x Inventories 615 x Total current assets $1,000 $1,100 $1,100 Net plant & equipment 1,000 x ,100 1,100 Total assets $2,000 $2,200 $2,200 Accounts payable $ 60 x 1.10 $ 66 $ 66 Notes payable c Accruals 140 x Total current liabilities $ 310 $ 330 $ Long-term bonds Total debt $1,060 $1,080 $1,139.6 Common stock c Retained earnings d Total common equity $ 940 $1,011.3 $1,060.4 Total liabilities & equity $2,000 $2, $2,200 Add’l funds needed (AFN) $ Cumulative AFN $ 108.7

4 Allied Food Products: Acutal 2005 and projected 2006 Balance Sheets ($ Millions) a AFN stands for “Additional Funds Needed.” This figure is determined at the bottom of Column 3 and Column 4 shows how the required $108.7 of AFN will be raised. b x 1.10 indicates “times 1 + g”; used for items which grow proportionally with sales. Here g = 0.10 c Indicates a 2005 amount carried over as the first-pass forecast. Arrows also indicate items whose values are carried over from one pass to another. d From Table 17-1, Line 13

5 The AFN Formula Additional Required Spontaneous Increase in funds = increase - increase in - retained needed in assets liabilities earnings AFN = (A*/S)  S - (L*/S)  S - MS 1 (1 - d) Descriptions of notations on following slides.

6 The AFN Formula AFN = additional funds needed. A*/S = assets that must increase if sales are to to increase expressed as a percentage of sales, or the required dollar increase in assets per $1 increase in sales. A*/S = $2,000/$3,000 = for Allied. Thus, for every $1 increase in sales, assets must increase by about 67 cents. Note that A designates total assets and A* designates those assets that must increase if sales are to increase. When the firm is operating at full capacity, as is the case here, A* = A. Often, though, A* and A are not equal, and the equation must be modified or else the projected financial statement method must be used.

7 The AFN Formula L*/S = liabilities that increase spontaneously with sales as a percentage of sales, or spontaneously generated financing per $1 increase in sales. L*/S = ($60 + $140) / $3,000 = for Allied. Thus, every $1 increase in sales generates about 7 cents of spontaneous financing. Again, L* represents liabilities that increase spontaneously, and L* is normally much less than total liabilities (L). S 1 = total sales projected for next year. Note that S 0 designates last year’s sales. S 1 = $3,300 million for Allied.

8 The AFN Formula  S = change in sales = S 1 - S 0 = $3,300 million - $3,000 million = $300 million for Allied. M = profit margin, or rate of profit per $1 of sales. M = $114/$3,000 = for Allied. d = percentage of earnings paid out in common dividends, or the dividend payout ratio; d= $58/$114 = for Allied.

9 Financial Forecasting Latest Financial Financial Sales Cost Accounting Market Statements Forecast Forecasts Data Preliminary Projections: 1. Financial Statements 2. Financing Plan Modify 3. Resulting Ratios and Revise Evaluation: Is the preliminary plan a good one, or Bad Plan should it be modified? Good Plan Final Projections: 1. Financial Statements 2. Financing Plan 3. Resulting Ratios

10 Relationship between Growth in Sales and Capital Requirements Additional Required Spontaneous Increase funds = increase increase in in retained needed in assets liabilities earnings AFN = ( A )  S - ( L )  S - MS 1 (1-d) S Example :  S = $2,000: MS 1 (1-d) = $900 AFV = (1.4) ($2,000) - (0.20) ($2,000) - $900 = $2,800 - $400 - $900 = $1,500

11 Cooley Textiles Pro Forma Income Statement December 31, 2006 (Thousands of Dollars)

12 Cooley Textiles Pro Forma Balance Sheet (Asset side) December 31, 2006 (Thousands of Dollars)

13 Cooley Textiles Pro Forma Balance Sheet Continued December 31, 2006 (Thousands of Dollars)

14 AFN = (A/S 0 )  S - (L/S 0 )  S - MS 1 (1-d) 29, AFN = x (5400) x (5400) ,00036,000 AFN = 0.81 (5400) -.20 (5400) AFN = AFN = AFN =

15 Cooley Textiles Pro Forma Income Statement December 31, 2006 (Thousands of Dollars) 1,800 M = Profit Margin = = 5% 36,000 S 1 = 41, d = Dividend Payout Ratio = = 45% 1,800 M S 1 = 5% (41,400) = 2,070 = Net Income Addition to RE = M S 1 (1-d) =  S = 41, ,000 = 5,400