ANSWERS TO

END-OF-CHAPTER QUESTIONS

4-1. This rather simplistic forecast method assumes no other information is available
which would indicate a change in the observed relationship between sales and the
expense item, asset or liability being forecast. Furthermore, the percent of sales method
works best for projected sales levels that are very close to the base level sales used to
determine the "percent of sales." The greater the difference in predicted and base level
sales, in general, the less accurate will be the percent of sales forecast.
4-2. In a fixed cash budget, cash flow estimates are made for a single set of sales
estimates, whereas a variable budget involves the preparation of several cash flow
estimates, with each estimate corresponding to a different set of sales estimates.
4.3 A flexible (or variable) cash budget gives the firm's management more
information regarding the range of possible financing needs of the firm, and secondly, it
provides management with a standard against which it can measure the performance of
those subordinates who are responsible for the various cost and revenue items contained
in the budget.
4-4. The probable effect on cash flows would be as follows:
(a) increased cash inflow from sales but increased cash outflow to finance
needed increases in inventories and other assets.
(b) increased supply of available cash.
(c) decreased cash inflow.
(d) immediate decrease in cash inflows (or a cash outflow).
4-5. As a general rule, the budget period should be long enough to show the effect of
management policies yet short enough so that estimates can be made with reasonable
accuracy. Since some budgets, such as capital expenditure budgets, require long-range
planning in order to be effective while other budgets are more effective for shorter
periods, it would not be wise for a firm to establish a standard budget period for all
budgets. Instead, firms usually have a minimum of two and sometimes three types of
budgets. The short-term budget is very detailed and includes a cash budget covering 6
months to a year. The intermediate term budget will contain pro forma statements and
verbal descriptions of major investment/financing plans that cover 2 to 5 years. A long-
term plan would involve less detailed general statements about the firm's strategic plans
covering the next 3 to 10 years.
4-6. 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. This excess cash can then be
invested in securities or other profitable alternatives.
 4-7. The careful budgeting of cash is of particular importance to a seasonal operation
because cash flows are not continuous. The availability of cash resources must be
carefully planned in order that the normal operation of the firm can be continued during
slow periods. In addition, it is important to plan for future cash needs so that excess
funds may be invested.

SOLUTIONS TO
END-OF-CHAPTER PROBLEMS

Solutions to Problem Set A

4-1A.
2003 % of Sales 2004
Sales 12,000,000 15,000,000
Net Income 1,200,000 2,000,000

Current Assets 3,000,000 25% 3,750,000

Net fixed assets 6,000,000 50% 7,500,000
Total Assets 9,000,000 11,250,000

Liabilities and Owner's Equity

Accounts payable 3,000,000 25% 3,750,000

Long-term debt 2,000,000 NA 2,000,000
Total Liabilities 5,000,000 5,750,000

Common stock 1,000,000 NA 1,000,000

Paid-in capital 1,800,000 NA 1,800,000
Retained earnings 1,200,000 3,200,000
Common equity 4,000,000 6,000,000
Total Liabilities and Equity 9,000,000 11,750,000

DFN = (500,000)

4-2A.
a. % Credit Sales 0.5
 Sales
February 20,000
March 30,000
April (estimated) 40,000

Accounts receivable (3/31/03) 20,000

plus credit sales for April (50% x 40,000) 20,000
less collections from Feb sales (50% x 20,000 x .5) (5,000)
less collections from March sales(50% x 30,000 x .5) (7,500)
Accounts receivable (4/30/03) 27,500

b. Collections From:
April cash sales $ 20,000
February credit sales 5,000
March credit sales 7,500
$ 32,500

4-3A. Based upon the projections made, Sambonoza can expect to have total assets next
year equal to $1.8 million made up of the $1 million in fixed assets plus $800,000 (.2 x
$4 million) in current assets. These assets will be financed by known sources of funding
comprised of $900,000 in common equity [$800,000 + (.5)(.05)($4 million) = $900,000],
plus payables and trade credit equal to 10% of projected sales ($400,000) which totals
$1.3 million. This leaves $500,000 ($1.8 million - $1.3 million), which will need to be
raised to meet the financing needs of the firm.
4-4A. Instructor’s Note: This is an introductory percent of sales financial forecasting
problem. Students should be able to solve it after a first reading of the chapter.
(a) Projected Financing Needs = Projected Total Assets
= Projected Current Assets + Projected Fixed Assets

= { x $20 m} +{ $5m + $.1m} = $11.77m

(b) DFN = Projected Current Assets + Projected Fixed Assets
- Present LTD - Present Owner's Equity
- [Projected Net Income - Dividends]
- Spontaneous Financing

= { } + $5.1m - $2m
x $20m - $6.5m
 - [.05 x $20m - $.5m] - { x $20m}
DFN = $6.67m + $5.1m - $8.5m - $.5m - $2m = $.77m

(c) We first solve for the maximum level of sales for which DFN = 0:

DFN = ( - .05 - ) Sales – (5.1M-2M-6.5M +.5M)

DFN = .1833 SALES - $2.9M = 0

Thus, SALES = $15.82M

The largest increase in sales that can occur without a need to raise
"discretionary funds" is

$15.82M - $15M = $820,000.

4-5A.
Cash $ .1m Current Liabilities $.6m
Accounts Receivable .1m Long-Term Debt .4m
Inventories 1.0m Common Stock plus
Net Fixed Assets .8m Retained earnings 1.0m
$2.0m $2.0m