Executive Fruit
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a. Identify the steps necessary to financially plan and forecast for 2005, 2006, and 2007,
In order to plan the forecast, we start with a base year, for which the actual figures are available, which is year 2002 here. The next step is to identify the independent variables. These are those variables, whose value is to be ascertained from outside and are not dependant on any other variables. In this case the independent variables identified are Growth Rate,
Tax Rate, Interest Rate, NWC Sales Ratio, Fixed Assets /Sales, COGS/Sales, Payout Ratio. Using these, all the other figures can be worked out. The growth rate gives the new sales, COGS/Sales ratio will give us the cost of goods sold. EBIT is Sales – Cost of Goods Sold. The interest expense is dependant on the amount of debt and the interest rate. The tax rate is given and so we get the net income. On the balance sheet, the NWC Sales ratio and Fixed Assets/Sales will give us the NWC and fixed assets, given the level of sales. The remaining items will be debt and equity. These will depend on the assumptions made as has been done later.
b. Project future years using the growth rate assumptions in the Mini-case,
The projections are in the attached file. For the interest expense, the opening debt balance is taken. This is because, if the closing balance is taken, that will have feedback effects. The closing balance will given an interest amount, this will change the net income which will change the debt amount and that will change the interest. So there would be circular effect.
c. Determine what type and amount of financing may be required, taking into account the impact on leverage ratios,
d. Determine the impact of rising interest rates on future performance,
e. Assess alternative capital structures and impact on debt ratio and return on equity.
c, d and e is below
1. Equity Constant – In this scenario, the equity amount is only increased by the retained earnings. All other financing is taken as debt. The leverage ratios – debt ratio and interest coverage ratios are calculated. Under the first scenario of 10% interest rate, the debt ratio increases to 0.50 in 2007 assuming a sales growth rate of 10%. The interest coverage ratio decreases to 4.54.
Under the interest rate of 15%, the debt ratio increases to 0.512 and the interest cover decreases to 2.98.
In both the cases the debt ratio is below 60% as desired by the bankers. Though in the scenario of 15% interest rate, the interest cover ratio falls quite a bit, but is still close to 3.0.
2. 40% debt ratio – In this scenario, the equity is