Question

Problem 4-28 Percent-of-sales method [LO4-3]

The Manning Company has financial statements as shown next, which are representative of the company’s historical average. The firm is expecting a 30 percent increase in sales next year, and management is concerned about the company’s need for external funds. The increase in sales is expected to be carried out without any expansion of fixed assets, but rather through more efficient asset utilization in the existing store. Among liabilities, only current liabilities vary directly with sales.

Income Statement
Sales	$	240,000
Expenses		181,200
Earnings before interest and taxes	$	58,800
Interest		7,400
Earnings before taxes	$	51,400
Taxes		15,400
Earnings after taxes	$	36,000
Dividends	$	12,600

Balance Sheet
Assets			Liabilities and Stockholders' Equity
Cash	$	6,000	Accounts payable	$	23,300
Accounts receivable		57,000	Accrued wages		1,800
Inventory		81,000	Accrued taxes		3,700
Current assets	$	144,000	Current liabilities	$	28,800
Fixed assets		84,000	Notes payable		7,400
			Long-term debt		17,000
			Common stock		124,000
			Retained earnings		50,800
Total assets	$	228,000	Total liabilities and stockholders' equity	$	228,000

  

Using the percent-of-sales method, determine whether the company has external financing needs, or a surplus of funds. (Hint: A profit margin and payout ratio must be found from the income statement.) (Do not round intermediate calculations.)
The firm needs _______ in external funds

Answer 1

Answer:

A_o = current level of assets = $144,000
L_o = current level of liabilities = $28,800
ΔS/S_o = percentage increase in sales i.e. change in sales divided by current sales = 30% = 0.30
S₁ = new level of sales = $240,000 *(1.30) = $312,000
PM = profit margin = Earnings after taxes/Sales = $36,000/240,000 = 15% =0.15
b = retention rate = 1 - payout rate = 1 - (Dividend/Earnings after taxes) = 1 - (12,600/36,000) = 1 - 0.35 = 0.65

Additional Funds Needed = [A0 x (ΔS / S0)] - [L0 x (ΔS / S0)] - [S1 x PM x b]

= [$144,000 x 0.30] - [$28,000 x 0.30] - [$312,000 x 0.15 x 0.65]

= $43,200 - 8,400 - 30,420 = $4,380

The firm needs $4,380 in external funds.