Question

Conn Man’s Shops, a national clothing chain, had sales of $320 million last year. The business has a steady net profit margin of 6 percent and a dividend payout ratio of 25 percent. The balance sheet for the end of last year is shown. Balance Sheet End of Year (in $ millions) Assets Liabilities and Stockholders' Equity Cash $ 22 Accounts payable $ 72 Accounts receivable 27 Accrued expenses 28 Inventory 76 Other payables 44 Plant and equipment 115 Common stock 44 Retained earnings 52 Total assets $ 240 Total liabilities and stockholders' equity $ 240 The firm's marketing staff has told the president that in the coming year there will be a large increase in the demand for overcoats and wool slacks. A sales increase of 20 percent is forecast for the company. All balance sheet items are expected to maintain the same percent-of-sales relationships as last year,* except for common stock and retained earnings. No change is scheduled in the number of common stock shares outstanding, and retained earnings will change as dictated by the profits and dividend policy of the firm. (Remember, the net profit margin is 6 percent.) *This includes fixed assets, since the firm is at full capacity. a. Will external financing be required for the company during the coming year? Yes No b. What would be the need for external financing if the net profit margin went up to 7.50 percent and the dividend payout ratio was increased to 50 percent?

Answer 1

a)   yes additional funds are needed for the next year to the extent of $ 1.92M

Lets find out the Assets and liabilites projeced to increase as a result of increased sales

The balance Sheet as at year end is

Since Conn Man is operating at full capacity all the assets, including Plant and equipment needs an increase in proportion to the increased sale. so the assets projected to change is 240 ( 22+27+76+115) . marked in yellow color.     A* =   240

All Liabilities other than common stock and retained earnings ( those 2 are marked in red font- excluded) will increase in proportion to increased sales. The liabilities marked in Blue color will increase in relation to sales (72+28+44) = 144

L*    = 144

Formula for additional funds needed (AFN)

        =     $ 1.92 M

b )   the extent of external financing will be $ 4.8M

if margin Changed to 7.5 % or   0.075    

         and Pay out ratio change to 50%,

                  then RR   will be (1-0.50) =0.50

substituting the revised values in the formula,

  

             =   $ 4.8M