Financial Forecasting, Budgeting & Valuation

Budgets

Master starts with sales. Production = sales + ending inventory − beginning inventory. Flexible budget adjusts to actual volume.

Cost-volume-profit

• Breakeven units = fixed costs ÷ contribution margin per unit.
• Target units = (fixed costs + pretax profit) ÷ contribution margin per unit.
• Margin of safety = sales − breakeven. Operating leverage = contribution margin ÷ operating income.

Capital budgeting

• Net present value (NPV) ≥ 0 → accept (preferred method).
• Internal rate of return (IRR): rate where NPV = 0.
• Profitability index = present value of inflows ÷ investment.
• Payback ignores time value. Ignore sunk costs; include the depreciation tax shield.

Cost of capital

• After-tax debt = yield × (1 − tax rate).
• Capital asset pricing model (CAPM): risk-free + beta × (market − risk-free).
• Weighted average cost of capital (WACC) = weighted after-tax costs at market values.

Valuation

Income (discounted cash flow, terminal value = cash flow × (1 + g) ÷ (WACC − g)) · market (multiples) · cost (replacement).

Exam traps

• Working capital invested at the start is usually recovered at the end — include both cash flows.
• Opportunity costs are relevant to a decision; sunk costs never are.
• Flexible budget variances compare actual results with the budget flexed to actual volume, not the original static budget.