Question

The most recent financial statements for Astorino, Inc., are shown here:

Income Statement				Balance Sheet
Sales	$	26,900		Assets	$	63,700		Debt	$	27,900
Costs		18,800						Equity		35,800
Taxable income	$	8,100		Total	$	63,700		Total	$	63,700
Taxes (40%)		3,240
Net income	$	4,860

Assets and costs are proportional to sales. Debt is not. Equity will change depending on how much retained earnings are changing following a change in sales.

A dividend of $2,300 was paid, and the company wishes to maintain a constant payout ratio. Next year’s sales are projected to be $30,935.

1. What is the External Financing Needed when Sales increase from $26,900 to    $30,935?

2. For this part of the exercise, consider the balance sheet and income statement information provided at the beginning of the question. Assume that, together with the initial costs of $18,800, other administrative and selling costs for $8,100 are paid by the Astorino corporation. Compute the new Net Income and the sustainable growth rate for the company. Calculate the new level of sales under the assumption that sales grow at the sustainable growth rate (I am not asking for the External Financing Needed but only for the pro-forma level of sales).

3. For this part of the exercise, consider the balance sheet and income statement information provided at the beginning of the question. Let’s suppose you also have some extra information on the total debt amount of Astorino corporation. In particular, you are told that $20,000 are in the form of short-term debt (Notes, for instance), and the remaining $7,900 in the form of long-term debt. Given this more sophisticated piece of news, calculate the External Financing Needed under the assumption that the firm grows at the sustainable growth rate.

Answer 1

Using pro rata increase of everything , please find below comparison of incoe statement:

Sales	26900	30935
cost	18800	21620
taxable income	8100	9315
tax at 40%	3240	3726
net income	4860	5589
dividend	2300	2645
% of dividend	47.33%

Dividend is 47.33% of net income

so the amount which will be added to equity side will be = 5589-2645 = 2944

Assets will increase pro rata to sales =

Assets = 63700*(30935/26900) = 73255

Equity = 35800+ 2944 = 38744

Debt = assets - equity = 73255-38744 = 34511

Increase in debt (external financing needed)= 34511 - 27900 = 6611

answer (ii).

Costs as percentage of sales = 18800/ 26900 = 69.88%

So lets take sg&a 69.88% of taxable income = 69.88% * 8100 = 5660

new updated income statement is as follows:

Sales	26900
cost	18800
operating income	8100
Sg&a	5660
taxable income	2440
tax at 40%	976
Net Income	1464
Dividend	692.8395

Sustainable growth rate = ROE* (1-b) = 1464/33240 *(1-47.33%)

= 2%(approx.)

New level of sales = 26900*1.02 = 27438(approx)

Answer (iii):

Net Income will increase by 2% = 1464*1.02 = 1494

Net income - Dividend = retained earnings = 1494*(1-47.33%) = 786

Increase in assets = 63700*1.02 = 64974 - 63700 = 1274

Increase in debt = Increase in assets - Increase in equity = 1274- 786

Increase in debt = 488