Question

Problem 3-21 Calculating EFN

The most recent financial statements for Retro Machine, Inc., follow. Sales for 2017 are projected to grow by 25 percent. Interest expense will remain constant; the tax rate and the dividend payout rate will also remain constant. Costs, other expenses, current assets, fixed assets, and accounts payable increase spontaneously with sales.

RETRO MACHINE, INC. 2016 Income Statement
Sales				$	761,000
Costs					596,000
Other expenses					17,000
Earnings before interest and taxes				$	148,000
Interest paid					18,000
Taxable income				$	130,000
Taxes (20%)					26,000
Net income				$	104,000
Dividends	$	20,800
Addition to retained earnings		83,200

RETRO MACHINE, INC. Balance Sheet as of December 31, 2016
Assets				Liabilities and Owners’ Equity
Current assets				Current liabilities
Cash	$	22,040		Accounts payable	$	56,200
Accounts receivable		34,360		Notes payable		15,400
Inventory		71,320		Total	$	71,600
Total	$	127,720		Long-term debt	$	144,000
Fixed assets				Owners’ equity
Net plant and equipment	$	450,000		Common stock and paid-in surplus	$	130,000
				Accumulated retained earnings		232,120
				Total	$	362,120
Total assets	$	577,720		Total liabilities and owners’ equity	$	577,720

The firm is operating at full capacity and no new debt or equity is issued. Calculate the pro forma income statement and balance sheet for the company. What external financing is needed to support the 25 percent growth rate in sales? EFN

Answer 1

Step 1: Percentage of Sales Calculations

Cost/Sales	596000/761000	78.32%
Other expenses/Sales	17000/761000	2.23%
Net income/Sales	104000/761000	13.67%
Dividend/Net income	20800/104000	20.00%
accounts payable/Sales	56200/761000	7.39%
Cash/Sales	22040/761000	2.90%
accounts receivable/Sales	34360/761000	4.52%
Inventory/Sales	71320/761000	9.37%
Fixed asset/Sales	450000/761000	59.13%

Step 2: Pro-Forma Calculations

Forecasted Sales = Sales * (1+growth rate)

= 761000*1.25

= 951250

Cost	78.32% of 951250	745,019.00
Other expenses	2.23% of 951250	21,212.88
Dividend/Net income	20% of 951250	190,250.00
accounts payable	7.39% of 951250	70,297.38
Cash	2.90% of 951250	27,586.25
accounts receivable	4.52% of 951250	42,996.50
Inventory	9.37% of 951250	89,132.13
Fixed asset	59.13% of 951250	562,474.13

Step 3 : EFN calculation

Partial Pro-Forma Total Assets - Partial Pro-Forma Total Liabilities and Owners' Equity

(27586.25+42996.5+89132.13+562474.13) - (70297.38+15400+144000+362120)

722189.01-591817.38

130371.63

RETRO MACHINE, INC.
Proforma Income Statement 2017

Sales		951,250.00
Less:	Cost of goods sold	745,019.00	78.32%
Gross profit		206,231.00
Less:	other expenses	21,212.88	2.23%
EBIT		185,018.13
Less:	Interest	18,000.00
Income Before Income Tax (EBT)		167,018.13
Less: Income Tax		33,403.63	20.00%
Net Income		133,614.50
Less: Dividend		26,722.90	20.00%
Addition to retained earnings		106,891.60	80.00%

RETRO MACHINE, INC.
Proforma Balance Sheet 2017

Assets
Cash	27,586.25	2.90%
Accounts Receivable	42,996.50	4.52%
Inventory	89,132.13	9.37%
Total Current Assets	159,714.88
Net Fixed Assets	562,474.13	59.13%
Total Assets	722,189.01
Liabilities
Accounts Payable	70,297.38	7.39%
S.T notes Payable	15,400.00	NA
Total Current Liabilities	85,697.38
L.T.Debt	274,371.63	NA
Common stock	130,000.00	NA
Retained Earnings	232,120.00	NA
Owner's Equity	362,120.00
Total Liabilities & Equity	722,189.01

EFN = (A0/S0*(S1-S0)) - (L0/S0*(S1-S0)) - (PM*S1*b)

where

Ao - Assets (at time 0) which vary directly with Sales = 577,720

Lo - Liabilities (at time 0) which vary directly with Sales= 56,200

So - Current Sales =761,000

S1 - Projected Sales = 951,250

b - Retention ratio = Addition to retained earnings/Net Income = 83200/10400=80

PM - Profit Margin = Net income/Sales =104000/761000

EFN = (577,720/761,000*(951,250-761,000)) - (56200/761,000*(951,250-761,000)) - (104000/761000*951250*.80)

144430-14050-104000

26380