Questions Set 79: Solution

Solution
Financial Forecasting
As a financial analyst of FalconBuy.com, you need to prepare pro forma financial statements for 2012. FalconBuy.com has the following balance sheet as of December 31, 2011 ($ millions).
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Cash $ 3.5 Accounts payable $ 9.0
Receivables 26.0 Notes payable 18.0
Inventory 58.0 Accruals 8.5
Total current assets $ 87.5 Total current liabilities $ 35.5
Net fixed assets 35.0 Mortgage loan 6.0
Common stock 15.0
Retained earnings 66.0
Total Assets $122.5 Total Liab. & Capital $122.5
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In 2011, FalconBuy.com had sales of $350 million, net income of $10.5 million, and paid dividends of $4.2 million to common stockholders. The firm has been operating at full capacity. Assume that all ratios remain constant.
For the year 2012, FalconBuy.com projects its sales to be $420 million (an increase of $70 million). (1) Use the AFN general formula to compute the projected additional funds needed (AFN) for 2012; (2) What does your estimated AFN figure tell you about FalconBuy.com’s financing to support the sales increase in 2012?
Short-Term Financing Choices
Falcon Ski Company estimates that for the next quarter there is a 60% probability that it will have a $2 million cash deficit, and a 40% probability that it will have no deficit at all. The company can either (1) take out a 90-day unsecured loan at an interest rate of 1% per month or (2) establish a line of credit, costing an interest rate of 1% per month on the amount borrowed plus a commitment fee of $15,000. Both alternatives also require a 20% compensating balance for outstanding loans, and excess cash can be reinvested at a quarterly rate of 2.5%. Which source of financing gives the lower expected cost? Which financing option would you recommend?
Long-Term Financing Decisions
Falcon Air Conditioner (FAC) has $1 million in EBIT for year ended 2011 with the following balance sheet:
Balance Sheet As of December 31, 2011
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Assets Liabilities & Capital
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Current assets $2,000,000 Debt(@ 8%) $1,250,000
Net fixed assets 4,750,000 Common stock; $10 par 2,500,000
Preferred stock (@ 10%) 2,000,000
Retained earnings 1,000,000
Total Assets $6,750,000 Total Liabilities & Capital $6,750,000
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FAC expects that the existing debt and preferred stock will not be retired until the year 2014; hence they will remain in the same amount next year. FAC is expected to maintain its dividend payout ratio on common stock at the level of 10% next year. FAC’s corporate tax rate is 40%.
FAC plans to undertake an expansion project, which is expected to increase EBIT to $1.2 million in 2012 (an increase of $200,000 from the year 2008 EBIT). It needs $500,000 of external capital to finance the expansion, and it is considering the following three possibilities:
1. New bank term loan, with an interest rate of 10%; its sinking fund provision requires the loan to be fully amortized over the next 5 years, commencing in 2013.
2. New preferred stock, with a dividend rate of 12%.
3. 50,000 shares of new common stock to net the firm $10 per share.
Given the information above, compute the EPS under each alternative for the year 2012 using the following table (you don’t have to fill up all cells).

Items	DEBT	PREFERRED STOCK	COMMON STOCK
EBIT	$1,200,000	$1,200,000	$1,200,000
EPS