Question

You work for Shasta Inc. Sales are expected to grow by 30% next year. The firm is currently operating at 80% capacity. Current assets, current liabilities and cost of goods sold will grow with sales. Interest expense will not change. The firm pays out 78% of net income as dividends. Leave long-term debt constant. The current income statement and balance sheet are below. Please show your work. Carry work out to 1 decimal point.

Income Statement: Fiscal Year Ending	12/31/Y0
Sales	60
Cost of Goods Sold	30
Depreciation	5
Earnings Before Interest & Tax (EBIT)	25
Interest Expense	5
Earnings Before Tax	20
Taxes (25%)	5
Net Income	15

BALANCE SHEET (in M)

Assets		Liabilities and Net Worth
Fiscal Year Ending	12/31/Y0	Fiscal Year Ending	12/31/Y0
Total Current Assets	45	Total Current Liabilities	25
Net Prop & Equip	55	Long Term Debt	15
		Shareholder Equity	60
TOTAL ASSETS	100	TOTAL LIAB & EQUITY	100

a) Calculate the additional funds needed (AFN) using the balance sheet and income statement.

b) Calculate the AFN using the formula

c) Why are the two answers different? Explain.

Answer 1

A).

AFN = Projected increase in assets – spontaneous increase in liabilities – any increase in retained earnings

= 13.50 - 7.50 - (22*22%)

= $ 1.16

B).

AFN = (A*/S₀)ΔS – (L*/S₀)ΔS – MS₁(RR)

Where:

A* = Assets tied directly to sales and will increase

L* = Spontaneous liabilities that will be affected by sales. (NOTE: Not all liabilities will be affected by sales such as long-term debt)

S₀ = Sales during the last year

S₁ = Total sales projected for next year (the new level of sales).

ΔS = The increase in sales between S₀ and S₁

M = Profit margin, or the profit per unit of sales

MS₁ = Projected Net Income

RR = The retention ratio from Net Income and is also calculated as (1 – payout ratio)

AFN = (A*S₀)/ΔS – (L*S₀)/ΔS – MS₁(RR)

AFN = (58.5*60)/18 - (32.5*60)/18 - (27.88%*78*22%)

= $ 2