Question

The Optical Scam Company has forecast a sales growth rate of 20 percent for next year. Current assets, fixed assets, and short-term debt are proportional to sales. The current financial statements are shown here:
  

INCOME STATEMENT
Sales			$	31,700,000
Costs				26,426,900
Taxable income			$	5,273,100
Taxes				1,845,585
Net income			$	3,427,515
Dividends	$	1,371,006
Addition to retained earnings		2,056,509

  

BALANCE SHEET
Assets				Liabilities and Equity
Current assets	$	7,330,000		Short-term debt	$	5,389,000
				Long-term debt		7,291,000
Fixed assets		20,566,000
				Common stock	$	959,000
				Accumulated retained earnings		14,257,000
				Total equity	$	15,216,000
Total assets	$	27,896,000		Total liabilities and equity	$	27,896,000

  
a. Calculate the external funds needed for next year using the equation from the chapter. (Do not round intermediate calculations.)
  
External financing needed           $   
  
b-1. Prepare the firm’s pro forma balance sheet for next year. (Do not round intermediate calculations.)
   

BALANCE SHEET
Assets				Liabilities and equity
Current assets	$			Short-term debt	$
Fixed assets				Long-term debt
				Common stock	$
				Accumulated retained earnings
				Total equity	$
Total assets	$			Total liabilities and equity	$

b-2. Calculate the external funds needed. (Do not round intermediate calculations.)
  
External financing needed           $  

c. Calculate the sustainable growth rate for the company based on the current financial statements. (Do not round intermediate calculations. Enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
  
Sustainable growth rate             %

Answer 1

Part (a) - Calculation of External Funding Needed

External Funding needed =

[(Assets/Sales)*Δ in sales] - [(Debt/Sales)*Δ in sales] - [(PM*Projected sales)*(1-d)]

Now,

Assets/Sales = $27896000/31700000 = 0.88

Δ in sales = $31700000*20% = $6340000

Debt(Short Term)/Sales = $5389000/$31700000 = 0.17

PM (Profit Margin) = Net income/Sales = $3427515/$31700000 = 0.108

Projected Sales = $31700000 + 20% = $38040000

d = Dividend/Net Income = $1371006/$3427515 = 0.4

External Funding = 0.88*$6340000 - 0.17*$6340000 - (0.108*$38040000)*(1-0.4) = $5579200 - $1077800 - $2464992 = $2036408

Part (b)(1)

Due to change in sales percentage, Current assets, Fixed assets and Short term debt will also increase at the growth rate of sales

Note 1 - New Current Assets ($7330000 + 20%) = $8796000 Note 2 - New Fixed assets ($20566000 + 20%) = $24679200 Note 3 - Short term debt = ($5389000 + 20%) = $6466800

Note 4 - Retained Earnings

Retained Earnings = Openings Balance + Net increase in income*(1-Dividend rate) = $14257000 + (0.108*$38040000)*(1-0.4) = $16721992

Proforma Balance sheet

Assets	Amount	Liabilities & Equity	Amount
Current Assets	$8796000 (Note 1)	Short Term debt	$6466800 (Note 3)
Fixed Assets	$24679200 (Note 2)	Long term debt (No change)	$7291000
		Total Liabilities (A)	$13757800
		Common stock	$959000
		Retained Earnings	$16721992 (Note 4)
		Total Equity (B)	$17680992
Total Assets	$33475200	Total Equity and Liability (A+B)	$31438792 (Difference is External Funding amount calculated in part a)
		EFN (External Funding Required)	$2036408 ($33475200 - $31438792)

Part (b)(2)

Justification of external funding needed

Total Assets = $33475200

Total Liabilities = $31438792

Difference in balance sheet = ($33475208 - $31438792) = $2036408 Which is External Funding Requirement. Hence Adding $2036408 as External funding in liabilities or equity will tally the balance sheet

Part (c) - Calculation of Sustainable Growth Rate

Formula Sustainable growth rate = [ROE (Return on equity) * b]/[1-(ROE*b)]

In the formula ROE = Net Income/Total Equity = ($3427515/$17680992)=19.39% or 0.1939 b = Retention Ratio = ($Retained Earnings/Net income) b = ($2056509/$3427515) = 0.6

Putting the values in formula Sustainable Growth Rate = (0.1939*0.6)/[1-(0.1939*0.6)] = 0.11634/0.88366 = 13.17%