Question

5. Using regression analysis to forecast assets

The AFN equation and the financial statement–forecasting approach both assume that assets grow at relatively the same rate as sales. However, the relationship between assets and sales is often a little more difficult than that. In particular, some firms use regression analysis to predict the required assets needed to support a given level of sales.

Mile Brewing Co. has used its historical sales and asset data to estimate the following regression equations:

Accounts Receivable	=	–$95,420 + 0.249(Sales)
Inventories	=	$8,765 + 0.243(Sales)

Mile Brewing Co. currently has sales of $922,000, but it expects sales to grow by 20% over the next year. Use the regression models to calculate Mile Brewing Co.’s forecasted values for accounts receivable and inventories needed to support next year’s sales.

Forecasted Values for Next Year
Accounts receivable ……………………………?
Inventories……………………………………….?

Based on the next year’s accounts receivable and inventory levels predicted by Mile Brewing Co.’s regression equations, the firm’s DSO for next year is expected to be………………………………………………..? . Use 365 days as the length of a year in all calculations.

Several factors affect a firm’s need for external funds. Evaluate the effect of each following factor and place a check next to each factor that is likely to increase a firm’s need for external capital—that is, its AFN (additional funds needed). Check all that apply.

The firm previously thought its fixed assets were being operated at full capacity, but now it learns that it actually has excess capacity.

The firm’s forecasted sales are unexpectedly increased.

The firm’s inventory turnover decreases, with no effect on the sales forecast.

General Forge and Foundry Inc. has seen its profit margin eroded by increased competition over the last year, but its sales have remained steady. Assuming everything else is held constant, will this affect the firm’s AFN?

No, the firm’s AFN will not be affected, because the firm’s sales have remained constant.

Yes, the decrease in profit margin will affect the firm’s AFN even though its sales have remained constant.

Answer 1