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​(Financial forecastinglong dashpercent of sales​) Next​ year's sales for Cumberland Mfg. are expected to be ​$15.60...

​(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!!

Solutions

Expert Solution

(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 %


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