Question

Krogh Lumber's 2016 financial statements are shown here.

Krogh Lumber: Balance Sheet as of December 31, 2016 (Thousands of Dollars)
Cash	$1,800		Accounts payable	$7,200
Receivables	10,800		Notes payable	3,472
Inventories	12,600		Accrued liabilities	2,520
Total current assets	$25,200		Total current liabilities	$13,192
			Mortgage bonds	5,000
Net fixed assets	21,600		Common stock	2,000
			Retained earnings	26,608
Total assets	$46,800		Total liabilities and equity	$46,800

Krogh Lumber: Income Statement for December 31, 2016 (Thousands of Dollars)
	Sales	$36,000
	Operating costs including depreciation	30,783
	Earnings before interest and taxes	$5,217
	Interest	1,017
	Earnings before taxes	$4,200
	Taxes (40%)	1,680
	Net income	$2,520
	Dividends (60%)	$1,512
	Addition to retained earnings	$1,008

1. Assume that the company was operating at full capacity in 2016 with regard to all items except fixed assets; fixed assets in 2016 were being utilized to only 65% of capacity. By what percentage could 2017 sales increase over 2016 sales without the need for an increase in fixed assets? Round your answer to two decimal places.

Now suppose 2017 sales increase by 25% over 2016 sales. Assume that Krogh cannot sell any fixed assets. All assets other than fixed assets will grow at the same rate as sales; however, after reviewing industry averages, the firm would like to reduce its operating costs/sales ratio to 84% and increase its total liabilities-to-assets ratio to 42%. The firm will maintain its 60% dividend payout ratio, and it currently has 1 million shares outstanding. The firm plans to raise 35% of its 2017 forecasted interest-bearing debt as notes payable, and it will issue bonds for the remainder. The firm forecasts that its before-tax cost of debt (which includes both short- and long-term debt) is 10.5%. Any stock issuances or repurchases will be made at the firm's current stock price of $40. Develop Krogh's projected financial statements. What are the balances of notes payable, bonds, common stock, and retained earnings? Round your answers to the nearest hundredth of thousand of dollars.

Krogh Lumber Pro Forma Income Statement December 31, 2017 (Thousands of Dollars) 2016 2017 Sales $36,000 $ Operating costs (includes depreciation) 30,783 EBIT $5,217 $ Interest expense 1,017 EBT $4,200 $ Taxes (40%) 1,680 Net Income $2,520 $ Dividends $1,512 $ Addition to RE $1,008 $ Krogh Lumber Pro Forma Balance Statement December 31, 2017 (Thousands of Dollars) 2016 2017 Assets Cash $1,800 $ Accounts receivable 10,800 Inventories 12,600 Fixed assets 21,600 Total assets $46,800 $ Liabilities and Equity Payables + accruals $9,720 $ Short-term bank loans 3,472   Total current liabilities $13,192 $ Long-term bonds 5,000   Total liabilities $18,192 $ Common stock 2,000 Retained earnings 26,608   Total common equity $28,608 $ Total liab. and equity $46,800 $

Answer 1

Ans.

a) Sales for the year 2016 = $ 36,000

This is at 65% utilization of fixed assets. Hence, if the assets utilization is done at 100%

Sales will be = 36000/65% = $ 55,384.615 or $ 55,385

Therefore, increase in sales will be

= ($ 55,385 - $ 36,000)/$ 36,000*100 = 53.847 % or 53.85%

b)

With an increase in sales by 25% sales amount will be

36,000 + 25% = $ 45,000

Krogh Lumber Proforma Income Statement December 31, 2017
Particulars	2016	2017	Working Notes
Sales (a)	$36,000.00	$ 45,000.00
Operating costs (includes depreciation) (b)	$30,783.00	$ 37,800.00	Taken at 84% of sales
EBIT (c = a-b)	$ 5,217.00	$    7,200.00
Interest Expenses	$ 1,017.00	$    2,341.71	Total liabilities * 10.5% ( $ 22,302 *10.5%)
EBT	$ 4,200.00	$    4,858.29
Taxes (40%)	$ 1,680.00	$    1,943.32
Net Income	$ 2,520.00	$    2,914.97
Dividends	$ 1,512.00	$    1,748.98	60% of net income
Addition to RE	$ 1,008.00	$    1,165.99

Krogh Lumber Proforma Balance Sheet December 31, 2017
Particulars	2016	2017	Working Notes
Assets
Cash	$ 1,800.00	$    2,250.00	Adding 25% to 2016 Nos.
Accounts Receivable	$10,800.00	$ 13,500.00	Adding 25% to 2016 Nos.
Inventories	$12,600.00	$ 15,750.00	Adding 25% to 2016 Nos.
Fixed Assets	$21,600.00	$ 21,600.00
Total Assets	$46,800.00	$ 53,100.00
Liabilities and Equity
Payables + Accruals	$ 9,720.00	7805.7	Taken as 35% of Total Liabilities assuming all liabilities are interest bearing
Short term bank loans	$ 3,472.00	3472	As no information is given about this it is assumed unchanged.
Total Current Liabilities	$13,192.00	11277.7
Long term bonds	$ 5,000.00	11024.3	Total Liabilities - Current Liabilities
Total Liabilities	$18,192.00	22302	Taken from working below
Common Stock	$ 2,000.00	$    3,024.01	Taken as, 30798 - 27773.99
Retained Earnings	$26,608.00	$ 27,773.99	Opening bal + current year addition
Total Common Equity	$28,608.00	$ 30,798.00
Total Liab. And equity	$46,800.00	$ 53,100.00

Working Note

To keep Assets to liabilities ratio at 42%, liabilities would be

$ 53,100 * 42 % = $ 22,302