Base Case Assumptions

The body Shop Case study

Question 1: Base Case Assumptions

In order to derive this forecast, �percent-of-sales’ forecasting was used, which involves initially forecasting sales and then forecasting other financial statement accounts based on their direct relationship with sales. This method of forecasting was used due to the lack of information available (only the last three years of financial statements). As a result, every account in the pro forma financial statements are based on one or more key assumptions about their relationship with sales:

Sales: It is assumed that sales turnover will continue to grow at a rate of 11% every year. This figure is the historical average of growth (change) in the last 3 years and reiterates Patrick Gournay’s plans to increase sales. It is unlikely that the firm will be able to achieve 20% growth again as the firm has reached its �maturity phase’ in the business cycle (further discussed in 3).

COGS: A historical average was taken to get an initial percentage of 40% and then it was assumed that this would decrease at rate to the power of 1.05. The reason for this assumption is because Gournay stated that he aimed to specifically target and reduce costs. However, change is often initially met by resistance, so there may be considerable time lag for large-scale changes to occur. For this reason it is assumed that COGS would decrease at an exponential rate to the power of 1.05 (based on the historical average) (further discussed in 3).

Operating Expenses: For both types of operating expenses an initial rate based on the historical average was chosen, and then decreased at a rate to the power of 1.05. This was done for the same reason as COGS (further discussed in 3).

Restructuring Cost Rate: Restructuring costs are assumed to initially increase, and then decrease at a rate to the power of 1.1. This is because Gournay has plans to totally restructure the company (hence there will be large restructuring costs similar to those in 1999). However, after the initial restructuring is done, these costs will start to decrease. The rate of 1.1 was chosen as it means the costs will decline faster than the COGS and Operating expenses. This is because restructuring costs are one off occurrences that have very low future costs..

Interest Rate: Is initially 6% as required by the case study. However, for the following two years it is increased at a rate of 8% to account for the expectation of rising global interest rates (that were later realised) between the years of 2002-2004 (Frino, et al, 2006).

Tax Rate: The tax rate of 32% is based on the historical average between 2003 and 2004. The 2002 tax rate of 235% is a clear outlier that was the result of other company factors (like an accumulated tax payable and negative profits), and so was not included in the historical average. Instead, the average of

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