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 63% 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. 
   
3. Now suppose 2017 sales increase by 30% 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 85% 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 11.5%. 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

We need to consider following Ration to develop balance sheet - year 2017
Income Statement Projection
	Yesr 2016 $'00	Yesr 2017 $'000
Sales	36,000	46,800	30% increase in 2017 as cpmpared with Yr 2016
Operating Cost	30,783	39,780	Operating cost to sales ratio =85%
Operatimg margin	5,217	7,020
Gross Profit %	14%	15%
Interest expenses	1,017	1,172	11.5% on ( Total Debt= Short + Long dent) 11.5%* ( 3568+6627)
EBT	4,200	5,848
Less - tax@40%	1,680	2,339
Net income	2,520	3,509
Dividend @60%	1,512	2,105
net profit	1,008	1,403

	Yesr 2016 $'00	Yesr 2017 $'000	Remarks
Balance Sheet
Cash	1,800	2,340	As per Question - all assets will grow at the same rate as sales -30%
Account Receivable	10,800	14,040
Inventories	12,600	16,380
Fixed asset	21,600	21,600
Total Asset	46,800	54,360
Paybale + Accual	9,720	12,636
Short term bank Loan	3,472	3,568	35% *(Total Debt- Payable ) 35% *(22831-12636)
Total current Liability	13,192	16,204
Long term Bond	5,000	6,627	65% *(Total Debt- Payable ) 65% *(22831-12636)
Total Debt- Liability	18,192	22,831	42% of $ 54360
Common Stock	2,000	3,518	plug in
Retained earning	26,608	28,011	Closing Balance $26608+$1403
Total Equity	28,608	31,529
Total Liability+ Equity	46,800	54,360