The CFO Project

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ACCT 281 Fall 2019 The CFO Project Tannous Create an income statement and a balance sheet for years X1 through X5. You may use any accounting principles that seem appropriate, providing that they are GAAP. Your goal is to maximize the firm’s common stock price at the end of year 5, by making well-informed accounting and financial decisions. You should think of yourself as the CFO (chief financial officer) of this firm.

Balance Sheet for the year ending 12/31/X0 Assets Cash 100,000 Marketable Securities 1,262,000 Accounts Receivable 192,000 Inventory 420,000 Other Assets 150,000 Current Assets 2,124,000 Equipment 2,000,000 Accumulated Depreciation (200,000) Fixed Assets 1,800,000 Total Assets 3,924,000 Liabilities and Equity Accounts Payable 154,000 Other Current Liabilities 50,000 Current Liabilities 204,000 Mortgages 0 Total Liabilities 204,000 Common Stock 100,000 Paid in Capital 3,400,000 Retained Earnings 220,000 Total Equity 3,720,000 Total Liabilities and Equity 3,924,000

Income Statement for the year ended 12/31/X0 Sales 1,690,000 Cost of Goods Sold 780,000 Gross Profit 910,000 Operating expenses 640,000 Net income before taxes 270,000 Taxes 86,850 Net Income 183,150

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ASSUMPTIONS: 1 On 1/1/X1 the company purchased additional land, plant, and equipment totaling

$5,000,000. You must decide how much is allocated to each category and how you will depreciate each category. Remember that each category has different depreciation rules. Be sure to show the “Historical Cost” for each category (property, plant, and equipment) and the associated amount of accumulated depreciation on the balance sheet. You must also decide how the original equipment was depreciated and its asset life.

2 On 1/1/X1 the company took out a mortgage to cover part of the cost of the purchases.

The interest rate is 5.0%, the payments are semi-annual, and the maturity is 30 years. You must decide how much of a loan you think you will need, given your current financial structure. You also have the option of selling common stock to raise some of the money to pay for the asset expansion. You must take out a loan for at least $2,000,000. The maximum amount you can borrow is $7,500,000. You must decide the optimum amount of debt and equity. Please include a loan amortization schedule of your particular loan that shows the interest expense for each year.

3 Sales (in units) increase by 61% each year. The sales price is $26 in year X0, and the

price increases by 18% each year.

4 To make the analysis less complicated, assume the units in ending inventory at 12/31/X0 have a unit cost of $12. In successive years, the number of units in the ending balance of inventory will increase by 12% each year. The unit cost of inventory increases by 5% each year.

Hint #1: you will have to decide which inventory method to use for your analysis. I suggest either LIFO or FIFO. Hint #2: The unit cost of $12.00 is a simplifying assumption.

5 As the balance sheet shows, the firm needs $100,000 in the cash account for transactions

purposes. The firm takes any extra cash and invests the cash in marketable securities. You have an option of investing in corporate securities or municipal securities. The corporate securities have a return of 5.4% and the municipal securities have a return of 4.6%, but the municipal securities are federal income tax-free. Interest revenue is calculated by taking the previous year’s ending balance in marketable securities and multiplying by the rate of return from the type of securities selected. For instance, if you decide to invest the marketable securities in municipal securities during year one, (X1), interest revenue for year X1 would be $58,052 ($1,262,000 * 0.046 = $58,052). This calculation of interest revenue is simplistic and obviously unrealistic, but will keep you from having a circular logic problem in your Excel modeling.

6 The abridged income statement in year zero (X0) needs some explanation. “Operating

expenses” includes many accounts, such as wage expense, lease expense, etc. You will need to add a few line items to make the income statement more realistic. For instance, at a minimum you will need to add lines for depreciation and interest expense. In the

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base year, all expenses are lumped together as “operating expenses”, in future income statements you will need to show all material expenses as separate line items.

7 The federal corporate income taxes rates for all years will be the actual rates in effect for

the 2017 or 2018 tax year. These Federal Corporate Tax Rates can be found on the internet. Be sure to show a schedule for how you calculated federal income tax. Ignore state income taxes.

8 The P/E (called the price earnings ratio: price / earnings per share {EPS}) for all six years

will be the same. That is to say that the P/E in period zero is the same as the P/E in all years. Assume they issued stock in period zero and the price of the common stock is included in the financial statement information as of the end of period zero. You need to make this assumption to calculate the original P/E. If you decide to sell stock in period X1, you will need to calculate the stock price. Assume that the stock price on January 1, X1, when you need to raise money, will be based on the expected earnings of year X1. In other words, the market is guessing (accurately) about what your earnings will be as of year-end. You then use the P/E, using the EPS from year X1, to calculate the stock price. Remember, you may finance completely with debt, or you may elect to finance the new assets partly with debt and partly with the sale of additional common stock.

9 The par value of the stock is $0.10 (ten cents per share). The particular exchange on

which this stock is traded requires that the company have a minimum of 500,000 shares outstanding at all times.

10 Stock price will not go below $1.00 per share, in any year, even though you may have

incurred a loss in any year.

11 Create a schedule to show stock price for each year, and how you calculated it.

12 You will need to make many assumptions in the process of creating the financial statements for years X1 through X5. Please make a list of your assumptions.

REQUIRED Part One (80% of grade): In this assignment, assume that you are creating actual statements for years X1-X5. You will be graded on how well you do the accounting, the reasonableness of your assumptions and the appearance and “presentation” of your financial statements. Part Two (20%) As of the end of year five, do a five-year financial analysis of your company. At a minimum level, you should calculate all the ratios that were covered in class. Write a one-page financial analysis that provides a prospective investor with a good overview of the most recent financial results of the company. You will be graded on how well your analysis fits the information from your company. Hint: You will probably have to do financial analyses of other companies in courses like Finance and Strategy. This part of the project is an opportunity to create a financial forecasting/analysis

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framework that you can transport to other classes. Strange as it might seem, this framework might even be useful in “real life”. Bonus To make the project more realistic I have am asking you to think like a CFO. You will not be graded on the quality of your financial decisions. Your grade will be based on how well you do the accounting. To make the project more interesting I am adding a three percentage (3%) point bonus to your final grade for the individual who maximizes stock price in year X5. The primary criterion is the market value of the stock at the end of year 5, which in this case is directly related to GAAP EPS and pertains to your GAAP statements. (HINT: the price per share depends on how many shares are outstanding. You need to think hard about how much stock you sell in the first year of your analysis.) Check list for the project:

1. Is presentation reasonable? Easy to understand? Are all 5 years, for each statement, on one sheet of paper?

2. Does the balance sheet balance? 3. Are retained earnings correct? (Beg Bal + NI – Div = Ending Bal) 4. Did you include an amortization table for the loan? Is interest expense correct on the

income statement and the mortgage liability correctly stated on the balance sheet? 5. Are fixed assets done correctly? Is accumulated depreciation shown on the balance

sheet (accumulating)? Is depreciation expense correct on the income statement? 6. Have you separated current assets and current liabilities? Classified balance sheet? 7. Is there a table showing your tax expense calculation? 8. Is sales revenue correct? 9. Is there a schedule for CGS and ending inventory balances? Is CGS on the income

statement and inventory on the balance sheet correct? 10. Are assumptions reasonable? 11. Is interest revenue reasonable? 12. Did you calculate ratios for all five years? What are the trends? Did you plot the

ratios? 13. Did you do a written financial analysis?