Corporate Finance【Reading 41】Sample 2012, statements, prepares, because

Kingpin804

Jane Epworth, CFA, is preparing pro forma financial statements for Gavin Industries, a mature U.S. manufacturing firm with three distinct geographic divisions in the Midwest, South and West. Epworth prepares estimates of sales for each of Gavin’s divisions using economists’ estimates of next-period GDP growth and sums the three estimates to forecast Gavin’s sales. Epworth’s approach to estimating Gavin’s sales is:

A) inappropriate, because sales should be forecast on a firm-wide basis and are unlikely to be related to GDP growth.

B) appropriate.

C) inappropriate, because sales should be forecast on a firm-wide basis.

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Sales estimates can be more sophisticated than simply estimating a single growth rate. One common approach is to estimate the linear relationship between sales growth and economic growth and use this relationship to estimate sales growth based on economists’ forecasts of GDP growth. Segment-by-segment analysis can also be applied, summing segment or division sales forecasts to produce an overall sales forecast for the firm.

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Which item is least likely assumed to be a constant percentage of sales on a pro forma balance sheet?

A) Long-term debt.

B) Property, plant and equipment.

C) Inventory.

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The projected level of long-term debt will depend on the financing need or surplus that results from the net income projection and the assumptions about how the surplus will be used or the need will be financed. Current assets, long-term assets, and current liabilities are all more likely to grow proportionately with sales.

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Which of the following financial statement items is least likely proportional to sales in a sales-driven pro-forma financial statement?

A) Property, plant, and equipment.

B) Interest expense.

C) Selling, general and administrative expenses.

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Interest expense is usually forecast based on current payments on long-term debt and expected future long-term debt.

Kingpin804

Gerome Masseratti, CFA, and Charles Bataglia are working together to develop pro forma financial statements for one of their firm’s clients. During their initial meeting, Bataglia made a statement with which Masseratti did not agree. Which of the following is most likely the statement that Masseratti objected to?

A) “A firm’s return on equity (ROE) will not necessarily increase just because the firm’s total asset turnover increases.”

B) “If sales are forecast accurately, there is no need to reconcile the pro-forma income statement and balance sheet.”

C) “It is acceptable to forecast future sales using the average compound growth rate of historic sales.”

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A normal part of constructing pro forma statements is to reconcile the income statement and balance sheet. After the first iteration, there is typically a discrepancy between the total assets account and the total liabilities plus total equity accounts on the firm’s balance sheet. This discrepancy must be resolved through subsequent iterations in the pro forma statement based on assumptions about how a deficit is funded or how a surplus is used.