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Pro forma Statements and Cash Budget

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What are the basic benefits and purposes of developing pro forma statements and a cash budget?

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1. What are the basic benefits and purposes of developing pro forma statements and a cash budget?

a. Pro forma income statements, balance sheets and statements of cash flows are commonly understood as financial projections.

The purpose of financial projections of a new or an existing enterprise is to indicate the venture's potential, present a timetable for financial viability and lay a benchmark to measure the effectiveness of management's performance along the financial axis. It can also serve as an operating plan using financial benchmarks. Entrepreneurs need answers to questions that link strategic business decisions to financial plans and choices. What is likely to happen? When? What can go right along the way? What can go wrong? What has to happen to achieve business objectives and to increase or preserve options? Financially savvy entrepreneurs know that such questions trigger a process that can lead to creative solutions to their financial challenges and problems. Well-developed financial projections benefit the company because they are the key to this financial vigilance.

In fact, Pro forma income statements are the plan-for-profit part of financial management and can indicate the potential financial feasibility and the time frame of a new venture. Since usually the level of earnings or profits, particularly during the start-up years of a venture, will not be sufficient to finance operating asset needs, and since actual cash inflows do not always match the actual cash outflows on a short-term basis, a cash flow forecast that will indicate these conditions and enable management to plan cash needs is recommended. Further, pro forma balance sheets are used to detail the assets required to support the projected level of operations and, through liabilities and capital, to show how these assets are to be financed. The projected balance sheets can indicate if debt-to-equity ratios, working capital, current ratios, inventory turn over and the like are within acceptable limits required to justify future financings that are projected for the venture. Finally, a break even chart and a corresponding sensitivity analysis showing the level of sales and production that will cover all costs, including those costs that vary with production level and those that do not, is essential.

More on Pro forma Statements

Projected financial statements are typically developed with assumptions that are monthly for the first year and quarterly for the next few years into three-year or five-year term operating plans. Managers will typically break down the revenue item on the income statement into various revenue channels whether product or service. Based on pricing, which the market will bear, and the number of units that could be sold, product and service unit sales ...

Solution Summary

This solution identifies and discusses the basic benefits and purposes of developing pro forma statements and a cash budget.

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Prepare a Pro Forma Income Statement

1. Prepare a Pro Forma Income Statement
Net Sales =2,938 COGS=1,598 SG&A=475 Depreciation=45 Interest Exp=32 Tax=15%

Net Sales
Cost Of Goods Sold
Gross Profit
Selling & Admin Exp
Depreciation
Interest Exp
Income Before Taxes
Income Taxes
Net Profit

2. In a fixed cash budget, cash flow estimates are made for a single set of sales estimates,
a. Whereas a variable budget involves the preparation of several cash flow estimates, with each estimate corresponding to a different set of sales estimates.
b. Whereas a variable budget involves the preparation of one cash flow estimate, with each estimate corresponding to a different set of sales estimates.
c. Whereas a variable budget involves the preparation of several cash flow estimates, with each estimate corresponding to only one set of sales estimates.

3. A cash budget can also be used to determine the amount of excess cash on hand that will not be needed to finance future operations.
a.This excess cash cannot be invested in securities or other profitable alternatives.
b.This excess cash can then be invested in securities or other profitable alternatives.
c.There is never an excess cash to be invested in securities or other profitable alternatives.

4.(Time disparity ranking problem) The State Spartan Corporation is considering two mutually exclusive projects. The cash flows associated with those projects are as follows:
YEAR PROJECT A PROJECT B
0 -$50,000 -$50,000
1 15,625 0
2 15,625 0
3 15,625 0
4 15,625 0
5 15,625 $100,000

The required rate of return on these projects is 10 percent.
a. What is each project's payback period?
b. What is each project's net present value?

5. To buy a new house you take out a 25 year mortgage for $300,000. What will your monthly interest rate payments be if the interest rate on your mortgage is 8 percent?
rate (i) =
number of periods (n)=
present value (PV) = $300,000
future value (FV) = $0
type (0 = at end of period) = 0
monthly mortgage payment =

6. A cash budget is usually thought of as a means of planning for future financing needs. Why
would a cash budget also be important for a firm that had excess cash on hand?

7. Weighted Average Cost of Capital NPd=
a. the market price of the debt, plus flotation costs
b. the market price of the debt, less flotation costs
c. the market price of the debt, equal to flotation costs

8. kd =
a. the market price of the debt, plus flotation costs
b. After-tax cost of the debt (After-tax required rate of return on debt)
c. before-tax cost of the debt (before-tax required rate of return on debt)

9. kps =
a. the cost of internally generated common funds
b. After-tax cost of the debt (After-tax required rate of return on debt)
c. before-tax cost of the debt (before-tax required rate of return on debt)
d. the cost of preferred stock.

10. Cost of preferred stock) Your firm is planning to issue preferred stock. The stock sells for $115; however, if new stock is issued, the company would receive only $98. The par value of the stock is $100 and the dividend rate is 14 percent. What is the cost of capital for the stock to your firm?

11. (Cost of internal equity) Pathos Co.'s common stock is currently selling for $21.50. Dividends paid last year were $.70. Flotation costs on issuing stock will be 10 percent of market price. The dividends and earnings per share are projected to have an annual growth rate of
15 percent. What is the cost of internal common equity for Pathos?

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