The AFN equation provides useful insights into the forecasting process, but this equation assumes that all of the firm's key ratios remain constant, which is not likely to hold true. Consequently, it is useful to forecast the firm's financial statements. The firm begins with forecasting its which then feeds into the firm's balance sheet. Management looks at operating ratios and their relationship with industry and benchmark averages. The forecasted income statement begins with the prior year's income statement and is adjusted for the sales growth forecast. Some inputs for the income statement are not under the firm's control - for example, tax and interest rates. The forecasted balance sheet is calculated from asset ratios that management has reviewed and changed based on industry and benchmark averages. An Excel spreadsheet is used for this analysis because changes in assumptions, financing, and ratios can be made to the statements to review alternative scenarios. The impact of these changes on the firm's forecasted financial statements ultimately can be used to improve the firm's operations.
Quantitative Problem: At the end of last year, Edwin Inc. reported the following income statement (in millions of dollars):
Sales $4,270
Operating costs excluding depreciation 3,029
EBITDA $1,241
Depreciation 315
EBIT $926
Interest 130
EBT $796
Taxes (40%) 318
Net income $478
Looking ahead to the following year, the company's CFO has assembled this information:
1. Year-end sales are expected to be 4% higher than $4.27 billion in sales generated last year.
2. Year-end operating costs, including depreciation, are expected to increase at the same rates as sales.
3. Interest costs are expected to remain unchanged.
4. The tax rate is expected to remain at 40%.
On the basis of this information, what will be the forecast for Edwin's year-end net income?
(in millions of dollars)
Sales $
Operating costs including depreciation
EBITDA $
Depreciation
EBIT $
Interest
EBT $
Taxes
Net income $