Question

The 2017 financial statements for Growth Industries are presented below.

INCOME STATEMENT, 2017
Sales				$	240,000
Costs					170,000
EBIT				$	70,000
Interest expense					14,000
Taxable income				$	56,000
Taxes (at 35%)					19,600
Net income				$	36,400
Dividends	$	18,200
Addition to retained earnings		18,200

  

BALANCE SHEET, YEAR-END, 2017
Assets					Liabilities
Current assets					Current liabilities
Cash	$	7,000			Accounts payable	$	14,000
Accounts receivable		12,000			Total current liabilities	$	14,000
Inventories		21,000			Long-term debt		140,000
Total current assets	$	40,000			Stockholders’ equity
Net plant and equipment		180,000			Common stock plus additional paid-in capital		15,000
					Retained earnings		51,000
Total assets	$	220,000			Total liabilities and stockholders' equity	$	220,000

  

Sales and costs are projected to grow at 30% a year for at least the next 4 years. Both current assets and accounts payable are projected to rise in proportion to sales. The firm is currently operating at 75% capacity, so it plans to increase fixed assets in proportion to sales. Interest expense will equal 10% of long-term debt outstanding at the start of the year. The firm will maintain a dividend payout ratio of 0.50.

What is the required external financing over the next year? (Enter excess cash as a negative number with a minus sign.)

Answer 1

As a first step, we will have to caste the projected income statement for the year 2018.

Please see the table below. Please be guided by the last column titled "How it has been calculated?" to understand the mathematics. All financials are in $.

Projected Income Statement 2018	$	How it has been calculated?
Sales	312,000	240000 x (1 + 30%)
Costs	221,000	170000 x (1 + 30%)
EBIT	91,000	Sales - Costs
Interest expense	14,000	10% of long-term debt outstanding at the start of the year = 10% x 140,000
Taxable income	77,000	EBIT - Interest
Taxes (at 35%)	26,950	35% x Taxable income
Net income	50,050	Taxable income - taxes
Dividends	25,025	Net income x 50%
Addition to retained earnings	25,025	Net income - dividends

Please pay attention to the last item calculated above: Addition to retained earnings = $ 25,025

The firm is currently operating at 75% capacity. Sales corresponding to 75% fixed asset utilization = 240,000

Hence, sales at full capacity utilization = 240,000 / 75% = 320,000

As projected sales for 2018 is 312,000 < 320,000; there will be no need for capacity addition. Hence, fixed assets will remain at the same level as last year.

Now, let's create the projected balance sheet before external funding.

Please see the table below.

Projected BALANCE SHEET, YEAR-END, 2018
Assets	$	How it has been calculated?		Liabilities	$	How it has been calculated?
Current assets				Current liabilities
Cash	9,100	7000 x (1 + 30%)		Accounts payable	18,200	14000 x (1 + 30%)
Accounts receivable	15,600	12000 x (1 + 30%)		Total current liabilities	18,200
Inventories	27,300	21000 x (1 + 30%)		Long-term debt	140,000	Same as last year
Total current assets	52,000	Sum of above three		Stockholders’ equity
Net plant and equipment	180,000	Same as last year's figure		Common stock plus additional paid-in capital	15,000	Same as last year
				Retained earnings	76,025	Last year's figure + addition to retained earnings calculated at the end of projected income statement = 15,000 + 25,025
Total assets	232,000	Total current assets + Net plant & equipment		Total liabilities and stockholders' equity before external funding	249,225	Total current liabilities + long term debt + common stock + retained earnings

The required external financing over the next year = Total projected assets - Total projected liabilities and stockholders' equity before external funding = 232,000 - 249,225 = - $ 17,225

(The negative number signifies excess cash)