Question

Harvard Prep Shops, a national clothing chain, had sales of $350 million last year. The business has a steady net profit margin of 20 percent and a dividend payout ratio of 30 percent. The balance sheet for the end of last year is shown below:

Balance Sheet December 31, 20XX ($ millions)
Assets		Liabilities and Shareholders' Equity
Cash	$4	Accounts payable	$45
Account receivable	12	Accrued expenses	11
Inventory	60	Other payables	28
		Common stock	70
Plant and equipment	190	Retained earnings	112
Total assets	$266	Total liabilities and equity	$266

Harvard’s anticipates a large increase in the demand for tweed sport coats and deck shoes. A sales increase of 30 percent is forecast.

All balance sheet items are expected to maintain the same percent-of-sales relationships as last year, except for common stock and retained earnings. No change in the number of common shares outstanding is scheduled, and retained earnings will change as dictated by the profits and dividend policy of the firm.

a. Will external financing be required for the Prep Shop during the coming year?

multiple choice

• Yes

• No

b. What would the need for external financing be if the net profit margin went up to 25 percent and the dividend payout ratio was increased to 65 percent? (Enter the answer in millions. Round the final answer to 2 decimal places.)

Required new funds           $  million

Answer 1

(a)

(Amounts are in millions

Sales = $350

(+) Increase in sales @ 20% = $70

Total Sales = $420

Net Profit @ 20% = $84

(-) Dividend Payout @ 30% = $25

Retained Earnings = $59

Calculation of Increase in Assets

Total Assets in last year = $267

Assets to Sales = $266/350

= 76%

Total Assets of Coming year = $420*76%

= $319.20

Increase in Assets = $319.20-$266

= $53.2

Calculation of Increase in Liabilities:

Liabilities in last year = $45+11+28

= $84

Liabilities to Sales = $84/350

= 24%

Total liabilities of Coming year = $420*24%

= $100.8

Increase in Liabilities = $100.8-$84

= $16.8

Calculation of External Financing required:

External Financing = Increase in Assets-Increase in liabilities- Retained Income

= $53.20-$16.8-$59

= -$22.6

Since we have $22.6 excess assets, the external financing is not required.

Answer is "No"

b.

Calculation of External Financing Required if Net profit margin 25% and dividend Payout ratio 65%

Sales = $350

(+) Increase in sales @ 20% = $70

Total Sales = $420

Net Profit @ 30% = $126

(-) Dividend Payout @ 65% = $81.9

Retained Earnings = $44.1

External Financing = Increase in Assets-Increase in liabilities- Retained Income

= $53.20-$16.8-$44.1

= -$7.70 Million

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