Question

The following tables summarizes the 2019 income statement and end-year balance sheet of Drake’s Bowling Alleys. Drake’s financial manager forecasts a 10% increase in sales and costs in 2020. The ratio of sales to average assets is expected to remain at 0.40. Interest is forecasted at 5% of debt at the start of the year.

INCOME STATEMENT, 2019
(Figures in $ thousands)
Sales	$	1,480		(40% of average assets)a
Costs		1,110		(75% of sales)
Interest		31		(5% of debt at start of year)b
Pretax profit	$	339
Tax		136		(40% of pretax profit)
Net income	$	203

^a Assets at the end of 2018 were $3,600,000.

^b Debt at the end of 2018 was $620,000.

BALANCE SHEET, YEAR-END
(Figures in $ thousands)
Assets		$	3,800				Debt	$	620
							Equity		3,180
Total		$	3,800					$	3,800

a. What is the implied level of assets at the end of 2020? (Do not round your intermediate calculations. Enter your answer in thousands.)

b. If the company pays out 50% of net income as dividends, how much cash will Drake's need to raise in the capital markets in 2020? (Do not round your intermediate calculations. Enter your answer in thousands.)

c. If Drake's is unwilling to make an equity issue, what will be the debt ratio at the end of 2020? (Do not round your intermediate calculations. Round your answer to 2 decimal places.)

Answer 1

Dreake's Bowling Alley
	Year 2018	Year 2019	Year 2020
Asset at Year End	3,600,000	3,800,000	4,340,000.0
Average Asset		3,700,000	4,070,000.0	Inproportion to 2020 sales
Debt at Start pf The year		620,000	620,000
Interest @5% of SOY debt		31,000	31,000

Amt in $'000
Proforma Income Statement	Year 2019	Year 2020	Remarks
Sales	1,480	1,628	10% increase over 2019, 40 % of Average assets
Costs	1,110	1,221	10% increase over 2019,
Interest	31	31
Pretax Profit	339	376
Tax 40%	136	150
Net Income	203	226
Dividend paid 50% of Net income in 2020		113
Addition to Retained Earning		113

Ans a.
As the sales in 2020 is $1,628,000., the average asset of 2020 would be
=$1628000/40%=$4,070,000. Now the start of the year asset =$3,800,000
So End of 2020 Asset =2*4070000-3800000=$4,340,000

Ans b.
Let US make the Proforma Balance sheet of end of 2020
Assets	Amt $'000	Liab & Equity	Amt $'000	Remarks
Assets	4,340	Debt	620
		Equity	3293	$113,00 addition to reatined earning
		Additional Capital	427	Balancing Amt
Total Assets	4,340	Total Liab & Equity	4,340
Assuming the current debt remains unchanges, the balancing amount will be the new capital
So Drake needs to Raise $427,000 in the capital market to fund the sales increase

Ans c.
If no new equity is issued, the total $427,000 will be raised as debt.
In that case total Debt will be =$620,000+$427,000=		$                1,047,000
So Debt Ratio at the end of 2020 will be =1047000/4340000=0.24		(Total Debt /Total Asset)