Question

Leonard Industries wishes to estimate how much financing they will need using a pro forma balance sheet for December 31, 2017. The firm expects 2017 sales to total $3,000,000. The following information has been provided: 

A mimimum cash balance of $50,000 is desired. 

Marketable securities, accruals, other current liabilities, long-term debt, and common shares are expected to remain unchanged. 

Accounts Receivable represent 10% of sales. 

Inventories represent 12% of sales. 

A new machine costing $90,000 will be acquired during 2017.

Total depreciation for the year will be $32,000.

Assume the existing assets were fully deprecisted. 

Accounts payable represent 14% of sales. 

The firm’s net profit margin is 4%. 

The firm expects to pay out $70,000 in cash dividends during 2017. 

The December 31,2016 balance sheet follows.

Assets Liabilities and Shareholder Equity
Cash $45,000    Accounts Payable $395,000

Marketable Securities 15,000 Accruals 60,000

Accounts Receivable 255,000 Other current liabilities 30,000

Inventories 340,000    Total Current Liabilities $485,000

Total Current Assets $655,000    Long-term Debt 350,000

Net Fixed Assets 600,000 Total Liabilities $835,000

   Common Shares 200,000

   Retained Earnings 220,000
Total assets = Total Liabilities and Shareholder Equity = $1,255,000

1. How much, if any, additional financing will Leonard Industries require in 2017?
2. Describe at least three specific adjustments Leonard Industries could make to avoid the need for financing or planned excess. Provide these adjustments and the amounts of the adjustments.
3. Which of these adjustments, if any should they make?

Answer 1

Part a)

The additional financing Leonard Industries will require in 2017 is determined as below:

Proforma Balance Sheet
Leonard Industries
December 31, 2017
Assets
Current Assets
Cash	50,000
Marketable Securities	15,000
Accounts Receivable	300,000
Inventories	360,000
Total Current Assets		725,000
Net Fixed Assets (600,000 + 90,000 - 32,000)		658,000
Total Assets		$1,383,000
Liabilities and Stockholder's Equity
Current Liabilities
Accounts Payable	420,000
Accruals	60,000
Other Current Liabilities	30,000
Total Current Liabilities		510,000
Long-Term Debts		350,000
Total Liabilities		860,000
Common Stock		200,000
Retained Earnings (220,000 + 3,000,000*4% - 70,000)		270,000
Total Stockholder's Equity		470,000
External Funds Required (1,383,000 - 1,330,000)		53,000
Total Liabilities and Stockholder's Equity		$1,383,000

Answer for Part a is $53,000

Notes:

1) The value of external funds required is calculated as follows:

External Funds Required = Total Assets - Total Liabilities - Total Stockholder's Equity = 1,383,000 - 860,000 - 470,000 = $53,000

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Part b)

The three adjustments that can be made by Leonard Industries along with the value of each adjustment is given below:

1) Reduce the amount of dividend from $70,000 to $17,000 for 2017. This will increase the balance in retained earnings to $323,000, thereby, reducing the need to borrow funds from outside.

2) Reduce the amount towards investment in capital assets by $53,000. This reduction will result in total assets balance to be lesser by $53,000 which would cause both the sides of the balance sheet to be equal.

3) Issue additional shares of common stock for a value of $53,000. This would eliminate the need to borrow funds from outside. The company can also issue common stock in exchange for new machine (part payment).

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Part c)

In my opinion, the company should prefer to reduce the amount of dividend to $17,000 for the year 2017. It is because the acquisition of capital asset is necessary for undertaking growth and expansion projects which would add more value to the company in the long run (therefore, use of Option 2 in Part b is not advisable). Issuance of additional common stock is likely to change the capital structure of the company and would result in further dilution of company's ownership to some extent (therefore, use of Option 3 in Part b is not advisable).