MF8830: Entrepreneurial Finance and Venture Capital
Review Session 3
QianqianYu
Boston College
April 2, 2016
Problem 1 of Chapter 9 in LM
 [Forecasting Sales Growth Rates, Sales, and Profits] Petal Providers
Corporation opens and operates “mega” floral stores in the U.S. The idea
behind the super store concept is to model the U.S. floral industry after its
European counterparts whose flower markets generally have larger selections at
lower prices. Revenues were $1 million with net profit of $50,000 last year
when the first “mega” Petal Providers floral outlet was opened. If the economy
grows rapidly next year, Petal Providers expects its sales to grow by 50 percent.
However, if the economy exhibits average growth, Petal Providers expects a
sales growth of 30 percent. For a slow economic growth scenario, sales are
expected to grow next year at a 10 percent rate. Management estimates the
probability of each scenario occurring to be: rapid growth (.30); average
growth (.50), and slow growth (.20). Petal Providers net profit margins are also
expected to vary with the level of economic activity next year. If slow grow
occurs, the net profit margin is expected to be 5 percent. Net profit margins of
7 percent and 10 percent are expected for average and rapid growth scenarios,
respectively.
1
Problem 1 of Chapter 9 in LM
A. Estimate the average sales growth rate for Petal Providers for
next year.
 Average sales growth rate = Rapid growth rate x Rapid probability
+ Average growth rate x Average probability+ Slow growth rate x
Slow probability = (.50 x .30) + (.30 x .50) + (.10 x .20) = 32%
B. Estimate the dollar amount of sales expected next year under
each scenario, as well as the expected value sales amount.
 Sales with rapid growth = 1,000,000 x (1 + 50%) = 1,500,000
 Sales with average growth = 1,000,000 x (1 + 30%) = 1,300,000
 Sales with slow growth = 1,000,000 x (1 +10%) = 1,100,000
 Expected value sales = 1,000,000 x (1 + 32%) = 1,320,000
2
Problem 1 of Chapter 9 in LM
C. Estimate the dollar amount of net profit expected next year under
each scenario, as well as the expected value net profit amount.
 Net profit with rapid growth = 1,500,000 x 10% = 150,000
 Net profit with average growth = 1,300,000 x 7% = 91,000
 Net profit with slow growth = 1,100,000 x 5% = 55,000
 Expected value net margin = (.10 x .30) + (.07 x .50) + (.05 x .20)
= 7.5%
 Expected value net profit = Expected value sales*Net profit
margin =1,320,000 x 7.5% = 99,000
3
Problem 2 of Chapter 9 in LM
[Sustainable Growth Rates] Petal Providers Corporation, described in
Problem 1, is interested in estimating its sustainable sales growth rate.
Last year revenues were $1 million, the net profit was $50,000, the
investment in assets was $750,000, payables and accruals were $100,000,
and equity at the end of the year was $450,000 (i.e., beginning of year
equity of $400,000 plus retained profits of $50,000). The venture did not
pay out any dividends and does not expect to pay dividends for the
foreseeable future.
4
Problem 2 of Chapter 9 in LM
A. Estimate the sustainable sales growth rate for Petal Providers
based on the information provided in this problem.
 Sustainable growth rate is the rate supported without external
equity capital (i.e., through the retention of profits).
g
E Ending  E Beginning
E Beginning

450,000  400,000
 12.5%
400,000
 Or:
g = (Net Income/Common equity beginning) x Retention rate
= 50,000/400,000 x 1.00 = .125 x 1.00 = .125 = 12.5%
Retention rate is equal to 1 as the venture does not expect to pay
didvidends.
5
Problem 2 of Chapter 9 in LM
B. How would your answer in Part A change if economic growth is
average and Petal Providers’ net profit margin is 7 percent?
 Note (Historical View): The 12.5% sustainable growth rate in Part
A is based on last year’s operating performance and financial
policy relationships holding for this year. If we just revise last
year’s operating and financial relationships to reflect a net profit
margin increase from 5% to 7%, we would have:
 Net income = 1,000,000 x .07 = 70,000
 Other operating performance and financial policy relationships are
assumed to remain the same
 g = [(400,000 + 70,000) – 400,000]/400,000 = 70,000/400,000 = =
17.5%
6
Problem 2 of Chapter 9 in LM
 Note (Forward-Looking View): If sales grow at 30% this year to







$1,300,000 ($1,000,000 x .30) based on information in Problem 5, Petal
Providers will need to improve its operating performance, change its
financial policies, and/or obtain additional equity funds to support the
“gap” between a forecasted growth rate of 30% and the 12.5%
sustainable growth rate calculated in Part A.
Looking forward and assuming the 30% sales growth rate can be funded
this year and the asset turnover ratio will remain the same, the
sustainable sales growth rate for next year can be estimated as follows:
Expected sales = 1,000.000 x 1.30 = 1,300,000
Expected net income = 1,300,000 x 7% = 91,000
Expected total assets = 750,000 x 1.30 = 975,000
Expected retained profit = 91,000 x 1.0000 = 91,000
Beginning equity this year (last year’s ending equity) = $450,000
g = [(450,000 + 91,000) – 450,000]/450,000 = 91,000/450,000 = .2022
= 20.22%
7
Problem 2 of Chapter 9 in LM
 Or use the expanded model:
NI NS
TA
g


 RR
NS TA CEbeg
91, 000 1,300, 000 975, 000



1
1,300, 000 975, 000
45, 000
 20.22%
8
Problem 3 of Chapter 9 in LM
[Additional Funds Needed] Petal Providers Corporation, described
in Problem 1, is interested in estimating its additional financing
needs (AFN) to support a rapid increase in sales next year. Last year
revenues (NS) were $1 million, the net profit (NI) was $50,000, the
investment in assets (TA) was $750,000, payables and accruals
(AP+AL) were $100,000, and equity at the end of the year was
$450,000. The venture did not pay out any dividends and does not
expect to pay dividends for the foreseeable future (RR=1).
 See a similar example on pg. 334 of LM.
9
Problem 3 of Chapter 9 in LM
A. What would be your estimate of the additional funds needed next year to
support a 30 percent increase in sales?
 Sales=1M=1,000,000; TA=750,000; AP+AL=100,000; NI=50,000.
 Forecasted Sales = 1,000,000 x 1.3 = 1,300,000;.
 Change in Sales = 300,000

AFN =
AP  AL0
NI
TA
(NS )  0
(NS )  ( NS1 ) 0 ( RR0 )
NS0
NS0
NS0
= (750,000/1,000,000) x 300,000 – (100,000/1,000,000) x 300,000 1,300,000 x (50,000/1,000,000) x 1.00
= (.75 x 300,000) – (.10 x 300,000) – (1,300,000 x .05) x 1.00
= 225,000 – 30,000 – 65,000
= 130,000
10
Problem 3 of Chapter 9 in LM
B. How would your answer in Part A change if the expected sales growth
were only 15 percent?
 Sales=1M=1,000,000; TA=750,000; AP+AL=100,000; NI=50,000.
 Forecasted Sales = 1,000,000 x 1.15 = 1,150,000
 Change in Sales = 150,000

AFN =
AP  AL0
NI
TA
(NS )  0
(NS )  ( NS1 ) 0 ( RR0 )
NS0
NS0
NS0
= (750,000/1,000,000) x 150,000 – (100,000/1,000,000) x 150,000 –
1,150,000 x (50,000/1,000,000) x 1.00
= (.75 x 150,000) – (.10 x 150,000) – (1,150,000 x .05) x 1.00
= 112,500 – 15,000 – 57,500
= 40,000
11
Problem 4 of Chapter 9 in LM
[Sustainable Growth Rates and Additional Funds Needed] The
Minoso Corporation anticipates a 20 percent increase in sales for
2014 over its 2013 level. Minoso is currently operating at full
capacity and thus expects to increase its investment in both current
and fixed assets in order to support the increase in forecasted sales.
12
Problem 4 of Chapter 9 in LM
A. Estimate Minoso’s sustainable sales growth rate based on the financial
data relationships for 2013. In making your estimate, calculate each
component of the firm’s operating performance and financial policies.
g
NI NS TA


 RR
NS TA CEbeg
 g = operating performance x financial policies = (net profit margin x
asset turnover (or ROA)) x [(total assets/beginning common equity) x (1
– dividend payout policy)
 g = (960/15000) x (15000/12000) x (12000/(2400 + 2800 – 576)) x (1 .40)
= .064 x 1.250 x 2.595 x .600 = .1246 = 12.46%
• See highlighted items on the income statements and balance sheet in
next slide.
13
Problem 4 of Chapter 9 in LM
Minoso Corporation
Income Statement for December 31, 2013
(Thousands of Dollars)
_________________________________
Sales
$15,000
Operating expenses
-13,000
EBIT
2,000
Interest
400
EBT
1,600
Taxes (40%)
640
Net income
960
Cash dividends (40%)
384
Added retained earnings
$576
Balance Sheet as of December 31, 2013
(Thousands of Dollars)
______________________________________________________________________________
Cash
$ 1,000
Accounts payable
$ 1,600
Accounts receivable
2,000
Bank Loan
1,800
Inventories
2,200
Accrued liabilities
1,200
Total current assets
5,200
Total current liabilities
4,600
Long-term debt
2,200
Fixed assets, net
6,800
Common stock
2,400
Total assets
$12,000
Retained earnings
2,800
Total liabilities & equity
$12,000
______________________________________________________________________________
14
Problem 4 of Chapter 9 in LM
B. Estimate the additional funds needed (AFN) for 2013 using the formula
or equation method that is based on constant “percent of sales”
relationships.
 2014 sales = 15000 x 1.20 = 18000; change in sales = 3000 (i.e., 18000
– 15000)

AFN =
AP  AL0
NI
TA
(NS )  0
(NS )  ( NS1 ) 0 ( RR0 )
NS0
NS0
NS0
= [(12000/15000) x 3000] – [((1600 + 1200)/15000) x 3000] – [18000 x
(960/15000) x (1 - .40)]
= .800(3000) - .1867(3000) – 18000(.064)(.60)
= 2400 -560.1 – 691.2 = 1148.7
• See highlighted items on the income statements and balance sheet in
next slide.
15
Problem 4 of Chapter 9 in LM
Minoso Corporation
Income Statement for December 31, 2013
(Thousands of Dollars)
_________________________________
Sales
$15,000
Operating expenses
-13,000
EBIT
2,000
Interest
400
EBT
1,600
Taxes (40%)
640
Net income
960
Cash dividends (40%)
384
Added retained earnings
$576
Balance Sheet as of December 31, 2013
(Thousands of Dollars)
______________________________________________________________________________
Cash
$ 1,000
Accounts payable
$ 1,600
Accounts receivable
2,000
Bank Loan
1,800
Inventories
2,200
Accrued liabilities
1,200
Total current assets
5,200
Total current liabilities
4,600
Long-term debt
2,200
Fixed assets, net
6,800
Common stock
2,400
Total assets
$12,000
Retained earnings
2,800
Total liabilities & equity
$12,000
______________________________________________________________________________
16
Problem 4 of Chapter 9 in LM
C. Briefly describe differences in calculation assumptions between Part A
and Part B.
 The sustainable sales growth rate calculation assumes a constant
financial leverage policy such that all forms of debt (current liabilities
and long-term debt) will change with changes in sales.
 The AFN equation assumes only accounts payables and accrued
liabilities will change with changes in sales. That is notes payable (bank
loans) and long-term debt changes must be negotiated and thus will not
automatically change with sales.
 Thus, if the 12.46% sustainable sales growth percentage is inserted in
the AFN equation (instead of 20%), the AFN will not be zero because of
the differences in the financial leverage assumptions between the two
equations.
17
Problem 5 of Chapter 9 in LM
 [Sustainable Sales Growth Rates and Additional Funds
Needed] Following are two years of income statements and
balance sheets for the Munich Exports Corporation.
18
Problem 5 of Chapter 9 in LM
 Balance Sheet
 Income Statement
Cash
Accounts receivable
Inventories
Total current assets
Fixed assets, net
Total assets
Accounts payable
Accruals
Bank loan
Total current liabilities
Long-term debt
Common stock ($.05 par)
Additional paid-in-capital
Retained earnings
Total liabilities and equity
2012
$ 50,000
200,000
450,000
700,000
300,000
$1,000,000
130,000
50,000
90,000
270,000
400,000
50,000
200,000
80,000
$1,000,000
2013
$ 50,000
300,000
570,000
920,000
380,000
$1,300,000
$ 180,000
70,000
90,000
340,000
550,000
50,000
200,000
160,000
$1,300,000
Net sales
Cost of goods sold
Gross profit
Marketing
General and administrative
Depreciation
EBIT
Interest
Earnings before taxes
Income taxes (40% rate)
Net income
2012
$1,300,000
780,000
520,000
130,000
150,000
40,000
200,000
45,000
155,000
62,000
$ 93,000
2013
$1,600,000
960,000
640,000
160,000
150,000
55,000
275,000
55,000
220,000
88,000
$ 132,000
$37,000
$52,000
Cash dividends
19
Problem 5 of Chapter 9 in LM
 A. Munich has a target dividend payout of 40 percent of net income.
Based on the 2013 financial statements relationships, estimate the
sustainable sales growth rate for the Munich Corporation for 2014.
 2012 total common (stockholders’) equity = 50,000 + 200,000 + 80,000
= 330,000
 Actual 2013 total common equity = 50,000 + 200,000 + 160,000 =
410,000
 g = (410,000 – 330,000)/330,000 = 80,000/330,000 = .2424 = 24.24%
 Note: actual dividend payout ratio was 39.39% (52,000/132,000) with a
retention rate of 60.61% (1 – 39.39%).
20
Problem 5 of Chapter 9 in LM
B. Show how your answer in Part A would change if Munich decided not to
pay any dividends in 2014.
 Retention rate = 1.00 or 100%
 Retention amount = 132,000 x 1.00 = 132,000
 Revised 2013 total common equity = 330,000 + 132,000 = 462,000
 g = (462,000 – 330,000)/330,000 = 132,000/330,000 = .4000 = 40.00%
21
Problem 5 of Chapter 9 in LM
C. Assume the Munich Corporation wants to grow its sales by 40 percent
in 2014 over its 2013 level. Estimate the additional funds needed that will
be necessary to support this rapid increase in sales.
 Forecasted Sales = 1,600,000 x 1.40 = 2,240,000
 Change in Sales = 2,240,000- 1,600,000 = 640,000
 Assume target dividend payout of 40%
AFN =
AP  AL0
NI
TA
(NS )  0
(NS )  ( NS1 ) 0 ( RR0 )
NS0
NS0
NS0
= (1,300,000/1,600,000) x 640,000 – ((180,000 +70,000)/1,600,000) x
640,000 –2,240,000 x (132,000/1,600,000) x (1 – .40)
= (.8125 x 640,000) – (.15625 x 640,000) – (2,240,000 x .0825) x .60
= 520,000 – 100,000 – (184,800 x .60) = 520,000 - 100,000 – 110,880
= 309,120
 See the next slide for detailed items used in the above formula.
22
Problem 5 of Chapter 9 in LM
Cash
Accounts receivable
Inventories
Total current assets
Fixed assets, net
Total assets
Accounts payable
Accruals
Bank loan
Total current liabilities
Long-term debt
Common stock ($.05 par)
Additional paid-in-capital
Retained earnings
Total liabilities and equity
2012
2013
$ 50,000
$ 50,000
200,000
300,000
450,000
570,000
700,000
920,000
300,000
380,000
$1,000,000 $1,300,000
130,000 $ 180,000
50,000
70,000
90,000
90,000
270,000
340,000
400,000
550,000
50,000
50,000
200,000
200,000
80,000
160,000
$1,000,000 $1,300,000
Net sales
Cost of goods sold
Gross profit
Marketing
General and administrative
Depreciation
EBIT
Interest
Earnings before taxes
Income taxes (40% rate)
Net income
2012
2013
$1,300,000 $1,600,000
780,000
960,000
520,000
640,000
130,000
160,000
150,000
150,000
40,000
55,000
200,000
275,000
45,000
55,000
155,000
220,000
62,000
88,000
$ 93,000 $ 132,000
Cash dividends
$37,000
$52,000
23
Problem 5 of Chapter 9 in LM
 D. Sales are forecasted to increase an additional 20 percent in 2015 over
2014. Estimate the two-year AFN that the Munich Corporation will need
to finance its 2014 and 2015 sales growth plans.
 Estimated 2015 sales = 1,600,000 x 1.40 x 1.20 = 2,688,000
 Change in Two-Year Sales = 2,688,000 – 1,600,000 = 1,088,000
 Assume target dividend payout of 40%

AFN =
AP  AL0
NI
TA
(NS )  0
(NS )  ( NS1 ) 0 ( RR0 )
NS0
NS0
NS0
= (1,300,000/1,600,000) x 1,088,000 – ((180,000 +70,000)/1,600,000) x
1,088,000 –4,928,000 x (132,000/1,600,000) x (1 – .40)
= (.8125 x 1,088,000) – (.15625 x 1,088,000) – (4,928,000 x .0825) x .60
= 884,000 – 170,000 – (221,760 x .60) = 884,000 - 170,000 – 243,936 =
470,064
24
Problem 6 of Chapter 9 in LM
Minoso Corporation
Income Statement for December 31, 2013
(Thousands of Dollars)
_________________________________
Sales
$15,000
Operating expenses
-13,000
EBIT
2,000
Interest
400
EBT
1,600
Taxes (40%)
640
Net income
960
Cash dividends (40%)
384
Added retained earnings
$576
[Multi-Year Financial Statement Projections] The
Minoso Corporation anticipates a 20 percent increase
in sales for 2014, 2015, and 2016. Minoso is
currently operating at full capacity and thus expects
to increase its investment in both current and fixed
assets in order to support the increase in forecasted
sales. The Minoso Corporation’s 2013 income and
balance sheet statements are given in problem 4.
Balance Sheet as of December 31, 2013
(Thousands of Dollars)
______________________________________________________________________________
Cash
$ 1,000
Accounts payable
$ 1,600
Accounts receivable
2,000
Bank Loan
1,800
Inventories
2,200
Accrued liabilities
1,200
Total current assets
5,200
Total current liabilities
4,600
Long-term debt
2,200
Fixed assets, net
6,800
Common stock
2,400
Total assets
$12,000
Retained earnings
2,800
Total liabilities & equity
$12,000
______________________________________________________________________________
25
Problem 6 of Chapter 9 in LM
A. Prepare an Excel spreadsheet model that projects the income statement,
balance sheet, and statement of cash flows for 2014 prior to obtaining any
additional financing. Use a separate AFN long-term financing (liability/equity)
account to show the amount of financing needed to make the balance sheet
balance.
B. Extend your 2014 spreadsheet-based financial statement projections for two
additional years (2015 and 2016). What is the total amount of AFN needed over
the three-year period?
 Recap: Financial forecasting process to project financial statements
 1. Forecast sales
 2. Project income statement
 3. Project balance sheet
 4. Project statement of cash flows
 The total (cumulative) amount of AFN needed over the 2014-16 three-year
period is 3984.6 (almost 4000, or nearly $4 million since the data are presented
in thousands of dollars) prior to making any financing decisions.
26
Problem 6 of Chapter 9 in LM
 Part A and B:
2. Project Income
Statement
3. Project Balance
Sheet
In 2014, AFN=144005160-2200-24003520=1120
MINOSO CORPORATION
Financial Statement Projections
Note: Projections are Prior to New Financing Decisions
Sales Growth Rates------>
Income Statements
Net Sales
Operating Expenses
Interest
EBT
Taxes (40%)
Net Income (NI)
Cash Dividends (40% of NI)
Added Retained Earnings
Actual
2013
15000
-13000
-400
1600
-640
960
Percent
of Sales
100.0%
86.7%
2008
2013
1000
0
2000
2200
5200
6800
12000
Accounts Pay
Bank Loan
Acc Liab
Total Current Liab
Additional Funds Needed (AFN)
Long-Term Debt
Common Stock
Retained Earnings
Total Iiab & Equity
1600
1800
1200
4600
0
2200
2400
2800
12000
Forecast Basis
1.20 x Current Sales
.867 x Forecast Sales
Initially Fixed
40% of EBT
6.4%
-384
576
Balance Sheets
Required Cash
Surplus Cash
Accounts Rec
Inventories
Total Current Assets
Fixed Assets, Net
Total Assets
1. Forecast sales
40% of NI
6.7%
.067 x Forecast Sales
13.3%
14.7%
.133 x Forecast Sales
.147 x Forecast Sales
45.3%
80.0%
.453 x Forecast Sales
.800 x Forecast Sales
10.7%
.107 x Forecast Sales
8.0%
.080 x Forecast Sales
[+ Inc in Forecast RE]
20%
Forecast
2014
18000.0
-15600.0
-400.0
2000.0
-800.0
1200.0
20%
Forecast
2015
21600.0
-18720.0
-400.0
2480.0
-992.0
1488.0
20%
Forecast
2016
25920.0
-22464.0
-400.0
3056.0
-1222.4
1833.6
-480.0
720.0
-595.2
892.8
-733.4
1100.2
2014
2009
1200.0
0.0
2400.0
2640.0
6240.0
8160.0
14400.0
2015
2010
1440.0
0.0
2880.0
3168.0
7495.2
9792.0
17280.0
2016
2011
1728.0
0.0
3456.0
3801.6
8994.2
11750.4
20736.0
1920.0
1800.0
1440.0
5160.0
1120.0
2200.0
2400.0
3520.0
14400.0
2304.0
1800.0
1728.0
5832.0
2435.2
2200.0
2400.0
4412.8
17280.0
2764.8
1800.0
2073.6
6638.4
3984.6
2200.0
2400.0
5513.0
20736.0
27
Problem 6 of Chapter 9 in LM
 Statement of Cash Flows.
MINOSO CORPORATION
Statement of Cash Flows
Net Income
Change in A/R
Change in Inv.
Change in A/P
Change in Acc. Liab.
CF from Operations
2014
1200.0
-400.0
-440.0
320.0
240.0
920.0
2015
1488.0
-480.0
-528.0
384.0
288.0
1152.0
2016
1833.6
-576.0
-633.6
460.8
345.6
1430.4
Change in Fixed Assets, Net
CF from Investments
-1360.0
-1360.0
-1632.0
-1632.0
-1958.4
-1958.4
Change in Bank Loan
Change in Long-Term Debt
Change in Common Stock
Payment of Cash Dividends
CF from Financing
0.0
0.0
0.0
-480.0
-480.0
0.0
0.0
0.0
-595.2
-595.2
0.0
0.0
0.0
-733.4
-733.4
Net Cash Flow
Beginning Cash
Ending Cash Before Borrowing
Target Ending Cash
Additional Funds Needed (AFN)
-920.0
1000.0
80.0
1200.0
1120.0
-1075.2
1200.0
124.8
1440.0
1315.2
-1261.4
1440.0
178.6
1728.0
1549.4
Cumulative AFN
1120.0
2435.2
3984.6
28