Question

Forecasted Statements and Ratios

Upton Computers makes bulk purchases of small computers, stocks them in conveniently located warehouses, ships them to its chain of retail stores, and has a staff to advise customers and help them set up their new computers. Upton's balance sheet as of December 31, 2016, is shown here (millions of dollars):

Cash	$   3.5		Accounts payable	$   9.0
Receivables	26.0		Notes payable	18.0
Inventories	58.0		Line of credit	0
Total current assets	$ 87.5		Accruals	8.5
Net fixed assets	35.0		Total current liabilities	$ 35.5
			Mortgage loan	6.0
			Common stock	15.0
			Retained earnings	66.0
Total assets	$122.5		Total liabilities and equity	$122.5

Sales for 2016 were $350 million and net income for the year was $10.5 million, so the firm's profit margin was 3.0%. Upton paid dividends of $4.2 million to common stockholders, so its payout ratio was 40%. Its tax rate was 40%, and it operated at full capacity. Assume that all assets/sales ratios, (spontaneous liabilities)/sales ratios, the profit margin, and the payout ratio remain constant in 2017. Do not round intermediate calculations.

1. If sales are projected to increase by $50 million, or 14.29%, during 2017, use the AFN equation to determine Upton's projected external capital requirements. Enter your answer in millions. For example, an answer of $1.2 million should be entered as 1.2, not 1,200,000. Round your answer to two decimal places.
   $ million
   
2. Using the AFN equation, determine Upton's self-supporting growth rate. That is, what is the maximum growth rate the firm can achieve without having to employ nonspontaneous external funds? Round your answer to two decimal places.
   %
   
3. Use the forecasted financial statement method to forecast Upton's balance sheet for December 31, 2017. Assume that all additional external capital is raised as a line of credit at the end of the year and is reflected (because the debt is added at the end of the year, there will be no additional interest expense due to the new debt).
   Assume Upton's profit margin and dividend payout ratio will be the same in 2017 as they were in 2016. What is the amount of the line of credit reported on the 2017 forecasted balance sheets? (Hint: You don't need to forecast the income statements because the line of credit is taken out on last day of the year and you are given the projected sales, profit margin, and dividend payout ratio; these figures allow you to calculate the 2017 addition to retained earnings for the balance sheet without actually constructing a full income statement.) Round your answers to the nearest cent.

   Upton Computers Pro Forma Balance Sheet December 31, 2017 (Millions of Dollars)
   Cash	$
   Receivables	$
   Inventories	$
   Total current assets	$
   Net fixed assets	$
   Total assets	$
   Accounts payable	$
   Notes payable	$
   Line of credit	$
   Accruals	$
   Total current liabilities	$
   Mortgage loan	$
   Common stock	$
   Retained earnings	$
   Total liabilities and equity	$

Answer 1

Part (a)

All financials below are in $ mn.

Spontaneous asset, A* = 122.5; S₀ = Sales last year = 350; ΔS = increase in sales = 50; L* = spontaneous liabilities = Accounts payable + accruals = 9 + 8.5 = 17.5; M = Profit margin = 3%; S₁ = Projected sales = 350 + 50 = 400; RR = retention ratio = 1 - payout ratio = 1 - 40% = 60%

Hence, AFN = (122.5 / 350) x 50 - (17.5 / 350) x 50 - 3% x 400 x 60% = 7.80

Part (b)

We have to calculate ΔS If AFN = 0

Hence, (122.5 / 350) x ΔS - (17.5 / 350) x ΔS - 3% x 400 x 60% = 0

Or, 0.30ΔS - 7.20 = 0

Hence, ΔS = 7.2 / 0.3 = 24

Hence, the maximum growth rate the firm can achieve without having to employ non spontaneous external funds = ΔS / S₀ = 24 / 350 = 6.86%

Part (c)

g = growth rate = 50 / 350 = 14.29%

	(Millions of Dollars)	how it has been calculated
Cash	4.0	3.5 *(1 + 14.29%)
Receivables	29.7	26 *(1 + 14.29%)
Inventories	66.3	58 *(1 + 14.29%)
Total current assets	100.0	Sum of the above
Net fixed assets	40.0	35 *(1 + 14.29%)
Total assets	140.0	Sum of total current assets + Net fixed assets
Accounts payable	10.3	9 *(1 + 14.29%)
Notes payable	18.0	Same as last year
Line of credit	7.8	Equals AFN we have calculated before
Accruals	9.7	8.5 *(1 + 14.29%)
Total current liabilities	45.8	Sum of the above
Mortgage loan	6.0	Same as last year
Common stock	15.0	Same as last year
Retained earnings	73.2	last year figure + this year's retained earning = 66 + 400 x 3% x 60%
Total liabilities and equity	140.0	Total current liabilities+ Mortgage loan+ Common stock+ Retained earnings