Question

You work for Shasta Inc. Sales are expected to grow by 30% next year. The firm...

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.

Homework Answers

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

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