Question

EXCESS CAPACITY

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 69% 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.
   %
2. 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 83% 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%. 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

				2016	2017
Sales				$ 36,000	$ 45,000
Operating costs (includes depreciation)				$ 30,783	$ 37,350
EBIT				$   5,217	$   5,217
Interest Expenses				$    1,017	$    1,258
EBT				$   4,200	$   3,959
Taxes (40%)				$    1,680	$    1,584
Net Income				$   2,520	$   2,375
Dividend				$    1,512	$    1,425
Addition to RE				$    1,008	$       950
Cash				$    1,800	$    2,250
Accounts Receivable				$ 10,800	$ 13,500
Inventories				$ 12,600	$ 15,750
Fixed Assets				$ 21,600	$ 21,600
Total Assets				$ 46,800	$ 53,100
Payable +Accruals				$    9,720	$    9,720
Short term bank loans				$    3,472	$    3,472
Total Current Liabilities				$ 13,192	$ 13,192
Long-term bonds				$    5,000	$    7,671
Notes Payable				$         -	$    1,439
Total Liabilities				$ 18,192	$ 22,302
Common Stock				$    2,000	$    3,240
Retained Earnings				$ 26,608	$ 27,558
Total Common Equity				$ 28,608	$ 30,798
Total Liab. And equity				$ 46,800	$ 53,100
Total Liabilities to Total Assets				38.87%	42.00%