Question

1. Fire Corp financial statements:

    Pro forma income statement                              Pro forma balance sheet                 

       Sales                 $ 32000               Assets       $   25300      Debt          $   5800

       Costs                    24400                                                     Equity          19500

       Net income       $    7600               Total         $ 25,300      Total            $25,300

       It expects 15% sales increase. It also predicts every item on the balance sheet will increase by 15% as well. It currently pays no dividend.

1. Create the pro forma income statement and balance sheet with the new sales level.
2. What’s the retained earnings? and new equity level?
3. With no dividend, debt is the plug variable. what’s the new debt level?
4. If Fire Corp decides to pay half of income as dividend, cost and assets vary with sales, but not debt and equity, what’s the EFN?

Answer 1

FORMULATION OF NEW INCOME STATEMENT AND BALANCE SHEET: -

With 15% increase in sales, and every item of balance sheet, lets prepare new Income statement and balance sheetPA

Income Statement

Particulars	Amount($)
Income	36,800
Cost	24,400
Profits	12,400

Note: -

1. New Sales = 115% of 32,000

2. Question is silent about cost therefore we assumed it to remain same in this part.

Balance Sheet

Liabilities	Amount($)	Assets	Amount($)
Equity Share capital	10,025	Assets	29,095
Retained Earnings	12,400
Debt	6,670
		Total	29,095

Note: -

1. Assets = 115% of 25300

2. Equity = 115% of 19,500 = 22,425. Breakup of this 22,425 in Equity capital and retained earenings is as follows: -

Total Equity = 22,425

Less:- Retained earnings 12,400 (Income of this year and assuming this as first year of business)

Equity Share capital = 10,025

CALCULATION OF NEW EQUITY AND RETAINED EARNINGS

Retained earnings are nothing other than the amount of profit company adds in its reserves after deducting dividends declared. Since, here it is mentioned that company does not pays dividend, entire net profits will be retained earnings i.e. $12,400

Equity  is sum total of reserves and surplus and equity share capital. New Equity level will be 22,425 (19,500 x 1.15)

New Debt level As mentioned in question that there is no dividend payments anddebt is plug variable, therefore by balancing figure also i.e. assets - equity fund = Debt capital i.e. 29,025 - 22425 = $6,670 will be new debt capital.

CALCULATION OF NEW EFN: -

Lets draw new income statement as per details mentioned in question: -

Income Statement

Particulars	Amount($)
Income	36,800
Cost	28,060
Profits	8,740
Dividend	4,370
Retained Earnings	4,370

Note:-

1. Now in this part, it is mentioned in question that cost, assets vary with sales therefore multiplied original figures with 115% of both sales and cost.
2. Also mentioned that company distributes half of profits as dividend therefore 50% of 8,740 paid as dividend

Now lets draw Revised Balance sheet to determine new External Funds needed i.e. debt capital

  Balance Sheet

Liabilities	Amount($)	Assets	Amount($)
Equity Share Capital	10,025	Assets	29,095
Retained reanings	4,370
Debt(Bal. fig.)	14,700
		Total	29,095

Note: -

1. Equity capital is assumed to be same as we have calculated in above sub part i.e. 10,025.

2. Retained earnings is as calculated in Income statement of this subpart.

3. Debt i.e. new EFN will be balancing fig. i.e. 14,700

Therefore, Debt i.e. new EFN will be balancing fig. i.e. 14,700