Hi everybody. In this class you're going to review the process of constructing pro forma statement using Ysom example. Ysom Incorporation was founded in 2014 by Professor Shin at Yonsei University and Professor Lee at Severance Hospital, which is an affiliated institute of Yonsei University. Their company manufactured sleep disorder diagnostic instruments. Ysom expected rapid growth, because of Korean population structure where the number of people over 65 years old increases sharply. The similar population structure and change are expected in China as well. Ysom sales have picked up recently and expected to grow significantly in the near future. As cost of good sold is expected to be 60% of sales next year, but becomes 70% by 2021 as the market is getting competitive. Sales, general, and other administrative expenses is expected to be 10% of sales next year, but becomes 5% by 2021. Payout ratio is 20% for 2016, but grows to 45% by 2021. Ysom assumes that its depreciation is 10% of beginning fixed assets. Interest rate for long term debt is 5%, tax rate is 20%, projected fixed asset turnover ratio is 3. That is, fixed asset is one-third of sales. Permanent growth rate is 5% after 2020. Discount rate is 30%, discount rate for terminal value is 20%. Ysom's balance sheet and income statement for 2015 are given as the following. Using the above mentioned assumptions and 2015 income statement and balance sheet, construct pro forma income statement and balance sheet for years 2016 through 2021. First, we can estimate sales using sales growth assumption. Ysom's estimated sales for year 2016 is sales of year 2015 times 1 plus projected sales growth rate, which is 100%. So the estimated sales of 2016 is about 800,000 Korean Won. We can do the same for the years until year 2021 and get estimated sales. Next, cost of goods sold is 60% of sales in 2016 and grows to 70% of sales in 2021. Ysom's estimated cost of good sold is about 480,000 Korean Won for year 2016. You can do the same calculation for the following years. Next, SG&A is 10% of sales in 2016 and reduces to 5% of sales in 2021. We can simply multiply sales by 10% to get estimated SG&A. Ysom's estimated SG&A is about 80,000 Korean Won for year 2016. And you can do the same calculation for the following years. In order to calculate depreciation, you need to estimate fixed assets first. You assume that fixed asset turnover ratio is three, so required fixed asset is one-third of sales. If the beginning fixed asset is greater than required fixed asset, Ysom just maintain the level of fixed asset as the beginning level. So the estimated fixed asset for year 2016 is about 1 million Korean Won. We can get the estimated fixed asset for the rest of the period in the same way. Next, we are ready to estimate depreciation. It is 10% of beginning fixed asset. The estimated depreciation is about 100,000 Korean Won for year 2016. And you can do the same for the following years. EBIT is sales minus cost of goods sold minus SG&A minus depreciation. So the expected EBIT, for year 2016 is 140,000 Korean Won. And using the same formula you can estimate EBIT for the rest of the estimation period. In order to estimate interest expenses, we need to make pro forma balance sheet first. We assume that current assets and current liabilities are growing at the same rate of sales growth, but long-term debt remains the same. Then interest expenses are long-term debt times interest rate of 5%. So estimated interest expense for year 2016 is about 15,000 Korean Won. And you can do the same calculation for the rest of the estimation period. Next, taxable income is EBIT minus interest paid. Taxes are 20% of taxable income. So estimated taxable income for year 2016 is about 125,000 Korean Won. And you can do the same calculation for the rest of the periods. Tax rate is about 20% of taxable income, so taxable income times tax rate of 20% is the estimated tax amount. So the estimated tax amount for year 2016 is 25,000 Korean Won. You can do the same for the rest of estimation period. Net income is taxable income minus taxes. So the estimated net income for year 2016 is 100,000 Korean Won. You can do the same for the rest of the estimation period. Dividends are net income times payout ratio, addition to retained earnings is net income minus dividends. Therefore, the estimated dividends for year 2016 is 20,000 Korean Won. You can make estimation of dividends for the rest of the estimation period in the same way. Last addition to retained earnings is net income minus dividends. So, the estimated addition to retained earnings for year 2016 is 80,000 Korean Won. You can get the estimation of addition to retained earnings for the rest of the period in the same way. This table shows you the summary of pro forma income satement of Ysom Incorporation.
