Question

Example: Robertson Industries (RI) is creating projections of its financial for the next three years. Analysts’ predictions for average annual GDP growth for the period is 2.5%. A regression of industry growth vs. GDP growth is:

Industry growth = 0.13% + 0.9105 × GDP growth

RI’s 2014 income statement (in thousands) is:

Sales $10,000

COGS (6,500)

SG&A (excluding depreciation) (2,000) Depreciation expense (500)

Interest expense (150)

EBT $850

Taxes @ 40% (340)

Net Income $510

Example (cont.): RI’s market share is 10%, but RI expects it to grow to 12% over the next 5 years. The net PP&E is $5,000,000, and RI plans to expand it each year at the same rate of growth as projected sales; fixed capital investment will be financed 20% with cash and 80% with long-term bonds with a 6% coupon rate. RI expects that COGS and SG&A (excluding depreciation) will remain a constant percentage of sales, and that the 40% income tax rate will not change.

Create pro forma income statements for RI for 2015, 2016, and 2017.

The annual industry growth rate is estimated to be:

0.13% + 0.9105(2.50%) = 2.41%

RI’s annual growth rate of market share is estimated to be:

(12%/10%)1/5 − 1 = 3.71%

Example (cont.):

RI’s expected annual growth rate in sales is:

(1.0241)(1.0371) − 1 = 6.21%

Projected PP&E, change in PP&E, change in Bonds Payable, change in Depreciation, and change in Interest Expense (in thousands) are:

2015 2016 2017

PP&E $5,311 $5,641 $5,991

ΔPP&E 311 330 350

ΔBonds Payable 249 264 280

ΔDepreciation 31 33 35

ΔInterest expense 15 16 17

Example (cont.):

RI’s pro forma income statements:

2015 2016 2017

Sales $10,621 $11,281 $11,982

COGS (6,904) (7,333) (7,788)

SG&A (excluding depreciation) (2,124) (2,256) (2,396)

Depreciation expense (531) (564) (599)

Interest expense (165) (181)     (198)

EBT $897 $947 $1,001

Taxes @ 40% (359) (379) (400)

Net Income $538 $568 $600

Answer 1

The Computation of the rate of Growth of the Industry is given by the regression equation:

Industry growth = 0.13% + 0.9105 × GDP growth

Given, the GDP growth is 2.5%.

Hence, Industry Growth = 0.13%+0.9105×2.5%=> 2.41%

Robertson Industries (RI) has a market share of 10%and expects it to grow to 12% over the next 5 years.

The Compunded Annual Growth Rate is calculated by the formula:

CAGR= (Final value/Initial Value)^(1/t)-1

Hence, the Compund Annual Growth Rate of Market Share of RI= (12/10)^(1/5)-1= 3.71%

Now, combining the growth rate in industry and market share we get RI's growth rate.

RI’s expected annual growth rate in sales is:

(1+Industry Growth Rate)(1+Market share growth)-1

=>(1.0241)(1.0371) − 1 = 6.21%

Figures in $

2014(given) 2015 2016 2017 Remarks

Sales 10,000   10,621 11281     11982 [ Values Growth At 6.21%]

-COGS 6500 6,904 7,333   7,788 [ Values Growth At 6.21%]

-SG&A 2000 2,124   2,256 2,396 [ Values Growth At 6.21%]

-Depreciation 500 531    564   599 [ Values Growth At 6.21%]

-Interest 150 165 181 198 [NOTE 1]

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EBT 850     897 947 1,001

-Tax@40% 340 359 379 400

EAT 510 538    568 600

Note 1

Computation Of Interest

RI plans to expand PPE each year at the same rate of growth as projected sales; fixed capital investment will be financed 20% with cash and 80% with long-term bonds with a 6% coupon rate.

Year PPE Change in PPE Financed Through Loan @80% Interest

2014 5000 -- --- 150

2015 5311 311 249 165[ 150+0.06*249]

2016 5641 330 264 181[165+0.06*264]

2017 5991 350 280 198[181+0.06*280]

N.B: PPE in the sum is given as $500,000 but the sum is computed taking PPE as $5000