Question

Eagle Sports Supply has the following financial statements. Assume that Eagle’s assets are proportional to its sales.

INCOME STATEMENT, 2017
Sales	$	1,650
Costs		320
Interest		60
Taxes		270
Net income	$	1,000

BALANCE SHEET, YEAR-END
	2016				2017					2016				2017
Assets	$	4,200			$	4,500			Debt	$	1,500			$	1,600
									Equity		2,700				2,900
Total	$	4,200			$	4,500			Total	$	4,200			$	4,500

  

a. Find Eagle’s required external funds if it maintains a dividend payout ratio of 50% and plans a growth rate of 20% in 2018. (Do not round intermediate calculations. Round your answer to 2 decimal places.)

b. If Eagle chooses not to issue new shares of stock, what variable must be the balancing item?

• Debt

• Interest

• Dividends

• Retained earnings

c. What will be the value of this balancing item? (Do not round intermediate calculations. Round your answer to 2 decimal places.)

d. Now suppose that the firm plans instead to increase long-term debt only to $1,700 and does not wish to issue any new shares of stock. What is now the balancing item? (Do not round intermediate calculations. Round your answer to the nearest whole number.)

• Debt

• Interest

• Dividends

• Retained earnings

e. What will be the value of this new balancing item?

Answer 1

a. Net income in 2017 = $1000

Dividend pay out = $1000 *50% =$500

Retained earnings = $1000 - $500 = $500

Growth in Assets for 2018 = 20% * $4500 = $900

External financing needed = Growth in Assets for 2018 - Retained earnings

= $900 - $500 = $400

b. Debt must be the balancing item.

c. The amount of retained earnings i.e. $500 will be the value of debt if the firm chooses not to issue equity.

d. Dividends

e. Difference in debt if the firm wants debt to increase to $1700 = $1700 - 1600 = $100

Extra dividend payment = $500 - $100 = $400

Total dividend payment = $400 + $500 = $900