CP

428 CHAPTER 11 Financial Planning and Forecasting Financial Statements

capacity, so a small projected sales increase would bring with it a very large financial

requirement.^5

Excess Capacity Adjustments

Consider again the MicroDrive example set forth in Tables 11-2 and 11-3, but now as-

sume that excess capacity exists in fixed assets. Specifically, assume that fixed assets in

2002 were being utilized to only 96 percent of capacity. If fixed assets had been used to

full capacity, 2002 sales could have been as high as $3,125 million versus the $3,000

million in actual sales:

(11-2)

This suggests that MicroDrive’s target fixed assets/sales ratio should be 32 percent

rather than 33.3 percent:

(11-3)

Therefore, if sales are to increase to $3,300 million, then fixed assets would have to in-

crease to $1,056 million:

(11-4)

We previously forecasted that MicroDrive would need to increase fixed assets at

the same rate as sales, or by 10 percent. That meant an increase from $1,000 million

to $1,100 million, or by $100 million. Now we see that the actual required increase is

only from $1,000 million to $1,056 million, or by $56 million. Thus, the capacity-

adjusted forecast is $100 million $56 million $44 million less than the earlier

forecast. With a smaller fixed asset requirement, the projected AFN would decline

from an estimated $118 million to $118 million $44 million $74 million.

Note also that when excess capacity exists, sales can grow to the capacity sales as

determined above with no increase whatever in fixed assets, but sales beyond that level

will require fixed asset additions as calculated in our example. The same situation

0.32($3,300)$1,056 million.

Required level

of fixed assets

(Target fixed assets/Sales)(Projected sales)



$1,000

$3,125

0.3232%.

Target fixed assets/Sales

Actual fixed assets

Full capacity sales



$3,000 million

0.96

$3,125 million.

capacity

Full

sales



Actual sales

at which fixed assets

Percentage of capacity

were operated

(^5) Several other points should be noted about Panel d of Figure 11-4. First, if the firm is operating at a sales
level of $100 million or less, any expansion that calls for a sales increase above $100 million would require a
doublingof the firm’s fixed assets. A much smaller percentage increase would be involved if the firm were
large enough to be operating a number of plants. Second, firms generally go to multiple shifts and take
other actions to minimize the need for new fixed asset capacity as they approach Point B. However, these ef-
forts can only go so far, and eventually a fixed asset expansion will be required. Third, firms often make
arrangements to share excess capacity with other firms in their industry. For example, the situation in the
electric utility industry is very much like that depicted in Panel d. However, electric companies often build
jointly owned plants, or else they “take turns” building plants, and then they buy power from or sell power
to other utilities to avoid building new plants that would be underutilized.

Financial Planning and Forecasting Financial Statements 425