Question

The most recent financial statements for Scott, Inc., appear below. Sales for 2020 are projected to grow by 25 percent. Interest expense will remain constant; the tax rate and the dividend payout rate also will remain constant. Costs, other expenses, current assets, fixed assets, and accounts payable increase spontaneously with sales.

SCOTT, INC. 2019 Income Statement
Sales				$	772,000
Costs					628,000
Other expenses					33,500
Earnings before interest and taxes				$	110,500
Interest expense					17,600
Taxable income				$	92,900
Taxes (24%)					22,296
Net income				$	70,604
Dividends	$	19,940
Addition to retained earnings		50,664

SCOTT, INC. Balance Sheet as of December 31, 2019
Assets				Liabilities and Owners’ Equity
Current assets				Current liabilities
Cash	$	26,140		Accounts payable	$	65,000
Accounts receivable		35,650		Notes payable		20,300
Inventory		72,230		Total	$	85,300
Total	$	134,020		Long-term debt	$	120,000
				Owners’ equity
Fixed assets				Common stock and paid-in surplus	$	119,000
Net plant and equipment	$	229,000		Retained earnings		38,720
				Total	$	157,720
Total assets	$	363,020		Total liabilities and owners’ equity	$	363,020

What is the EFN if the firm wishes to keep its debt-equity ratio constant?

Answer 1

Answer :

First, we can calculate some of the Amounts for the Budgeted income statement as follows:

Dividend payout ratio = Dividend / Net income

= $19,940 / 70,604 = 28.24%

Sales for 2020 :

Sales 2020 = Sales of 2019 * ( 1 + 25% )

= $772,.000 * ( 1 + 25% ) = $965,000

Cost for 2020 :

Cost 2020 = Cost of 2019 * ( 1 + 25% )

= $628,000 * ( 1 + 25% ) = $785,000

Other expenses 2020 :

Other expenses 2020 = Otheer expenses of 2019 * ( 1 + 25% )

= $33,500 * ( 1 + 25% ) = $41,875

Now, we can calculate 2020 budgeted income statement as follows :

Budgeted Income Statement

Sales	$ 965,000
Cost	$ 785,000
Other expenses	$ 41,875
EBIT [ $ 965,000 - $ 785,000 - $ 41,875 ]	$ 138,125
Interest paid	$ 17,600
Taxable income [ $ 138,125 - $ 17,600 ]	$ 120,525
Tax @ 24% [ $ 120,525 * 0.24 ]	$ 28,926
Net income [ $ 120,525 - $ 28,926 ]	$ 91,599
Dividend [ $ 91,599 * 0.2824 ]	$ 25,867.56
Addition to retained earning [ $ 91,599 - $ 25,867.56 ]	$ 65,731.44

Now,

Total fund needed = ( Total asset - Accounts payable ) * % increase

= ( $ 363,020 - $ 65,000 ) * 25% = $ 74,505

Therefore,

EFN = Total fund needed - Addition to retained earning

= $ 74,505 - $ 65,731.44

EFN = $ 8,773.56