In: Finance
(Financial forecastinglong dashpercent of sales) Next year's sales for Cumberland Mfg. are expected to be $15.60 million. Current sales are $13 million, based on current assets of $4.33 million and fixed assets of $6.50 million. The firm's net profit margin is 5 percent after taxes. Cumberland estimates that its current assets will rise in direct proportion to the increase in sales, but that its fixed assets will increase by only $200,000. Currently, Cumberland has $1.50 million in accounts payable (which vary directly with sales), $2 million in long-term debt (due in 10 years), and common equity (including $2 million in retained earnings) totaling $7.33 million. Cumberland plans to pay $0.16 million in common stock dividends next year. a. What are Cumberland's total financing needs (that is, total assets) for the coming year? b. Given the firm's projections and dividend payment plans, what are its discretionary financing needs? c. Based on your projections, and assuming that the $200,000 expansion in fixed assets will occur, what is the largest increase in sales the firm can support without having to resort to the use of discretionary sources of financing?
Thank you!!
(a) Current Sales = $ 13 million, Projected Sales = $ 15.6 million, Growth Rate = [(15.6-13) / 13] x 100 = 20%,
Existing Current Assets = $ 4.33 million, Projected Current Assets = 4.33 x 1.2 = $ 5.196 million (as current assets are directly proportional to sales)
Existing Fixed Assets = $ 6.5 million, Projected Fixed Assets = $ 6.7 million (as the actual increase is only $ 200000 or $ 0.2 million)
Existing Accounts Payable = $ 1.5 million, Projected Accounts Payable = 1.5 x 1.2 = $ 1.8 million (as directly proportional to sales)
Existing Long-Term Debt = $ 2 million, Common Equity = $ 5.33 million and Retained Earnings = $ 2 million
Expected Dividend Payout = $ 0.16 million and Net Profit Margin = 5 %
Now, as per Asset - Liability Equation, we get:
Asset = Liability + Shareholder's Equity
For upcoming year:
Assets = Projected Current Assets + Projected Fixed Assets = 5.196 + 6.7 = $11.896 million
Total Financing Needs = $ 11.896 million
(b) For upcoming year:
Assets = Projected Current Assets + Projected Fixed Assets = 5.196 + 6.7 = $11.896 million
Total Financing Needs = $ 11.896 million
Liabilities = 1.8 + 2 = $ 3.8 million
Shareholder's Equity = Common Equity + Existing Retained Earnings + Increase in Retained Earnings = 5.33 + 2 + Sales x Profit Margin - Expected Dividend Payout = 5.33 + 2 + 15.6 x 0.05 - 0.16 = $ 7.95 million
Discretionary Financing Need = Total Assets - Total Liabilities - Shareholder's Equity (all projected values for next year) = 11.896 - 3.8 - 7.95 = $ 0.146 million
(c) Let the largest increase in sales that can be supported without discretionary financing need be y%
Therefore, Projected Assets = 4.33 x (1+y) + 6.7, Projected Liabilities = 1.5 x (1+y) + 2, Projected Sales = 13 x (1+y)
Projected Net Income = 0.05 x 13 x (1+y) = 0.065 x (1+y)
Increase in Retained Earnings = Projected Net Income - Dividend Paid Out = 0.065 x (1+y) - 0.16
Projected Shareholder's Equity = 7.33 (existing retained earnings plus common equity) + 0.65 x (1+y) - 0.16
If discretionary financing needs are zero, then: Projected Assets = Projected Liabilities + Projected Shareholder's Equity
4.33 x (1+y) + 6.7 = 1.5 x (1+y) + 2 + 7.33 + 0.65 x (1+y) - 0.16
4.33 + 6.7 + 4.33y = 1.5 + 1.5y + 2 + 7.33 + 0.65 + 0.65y - 0.16
11.03 + 4.33y = 11.32 + 2.15y
2.18 y = 0.29
y = 0.29 / 2.18 = 0.133027 or 13.3027 % ~ 13.3 %