Question

The table given below 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. At the end of 2018 debt was $2,400,000 and assets were $6,960,000.

Income Statement
$ in thousands
Sales	$	2,900	(40% of average assets)
Costs		2,175	(75% of sales)
Interest		120	(5% of debt at start of year)
Pretax profit		605
Tax		242	(40% of pretax profit)
Net income	$	363
						Balance Sheet
						$ in thousands
						Net assets	$	7,540		Debt	$	2,400
										Equity		5,140
						Total	$	7,540		Total	$	7,540
						a. What is the expected level of assets at the end of 2020? b. If the company pays out 50% of net income as dividends, how much cash will Drake need to raise in the capital markets in 2020? Assumes debt remains constant. c. If Drake is unwilling to make an equity issue, what will be the debt ratio at the end of 2020?

Answer 1

a. Level of sales in 2020 = 2900 *110% = 3190

Let x be level of assets in 2020

3190 = 40% * ( 7540 + x) /2

x =8410

Expected level of assets = 8410

b.

Sales	3,190
Costs	2,393	[75 % of sales]
Interest	120	[2400*5%]
Pre tax profit	678
Tax	271	[40% of pretax profit]
Net income	407
Less: Dividends paid	203	[50% of net income]
Income to stockholders	203

Assets	8410	Debt	2400
		Existing equity	5140
		Net income	203
		New equity	667
	8410		8410

Amount to be raised in capital markets = 667

c) If it is unwilling to make then it has to raise through debt. Then debt will be = 2400 + 667 = 3067

Debt ratio = 3067/ 8410 = 36.47%