Cash $ 3.5 Accounts payable $ 9.0 Receivables 26.0 Notes payable 18.0 Inventorie
ID: 2728666 • Letter: C
Question
Cash $ 3.5 Accounts payable $ 9.0
Receivables 26.0 Notes payable 18.0
Inventories 58.0 Line of credit 0
Total current assets $ 87.5 Accruals 8.5
Net fixed assets 35.0 Total current liabilities $ 35.5
Mortgage loan 6.0
Common stock 15.0
Retained earnings 66.0
Total assets $122.5 Total liabilities and equity $122.5
12-7) Upton Computers makes bulk purchases of small computers, stocks them in conveniently
located warehouses, ships them to its chain of retail stores, and has a staff to advise
customers and help them set up their new computers. Upton’s balance sheet as of
December 31, 2013, is shown here (millions of dollars):
Sales for 2013 were $350 million and net income for the year was $10.5 million, so the
firm’s profit margin was 3.0%. Upton paid dividends of $4.2 million to common
stockholders, so its payout ratio was 40%. Its tax rate was 40%, and it operated at full
capacity. Assume that all assets/sales ratios, spontaneous liabilities/sales ratios, the profit
margin, and the payout ratio remain constant in 2014.
a. If sales are projected to increase by $70 million, or 20%, during 2014, use the AFN
equation to determine Upton’s projected external capital requirements.
b. Using the AFN equation, determine Upton’s self-supporting growth rate. That is, what
is the maximum growth rate the firm can achieve without having to employ
nonspontaneous external funds?
c. Use the forecasted financial statement method to forecast Upton’s balance sheet for
December 31, 2014. Assume that all additional external capital is raised as a line
of credit at the end of the year and is reflected (because the debt is added at the end
of the year, there will be no additional interest expense due to the new debt).
Explanation / Answer
Additional funds needed (AFN) is calculated as the excess of required increase in assets over the increase in liabilities and increase in retained earnings.
Where,
Ao = current level of assets
S/So = percentage increase in sales i.e. change in sales divided by current sales
Lo = current level of liabilities
S1 = new level of sales
PM = profit margin
b = retention rate = 1 – payout rate
In a more simpler way , additional funds neeeded = increase in assets increase in liabilities – increase in retained earnings.
Now for solution to the above problem :
a. Increase in assets = 147-122.5 = 24.5 ( as calculated below)
Assets in 2013 = 122.5 Mn $ . Asset/Sales ratio in 2013 = 122.5/350 = 0.35.
Therefore Assets in 2014 ( since assets to sales ratio remains same ) = 0.35 ( 350 +70) = 147 Mn $.
b. Increase in Liabilities = 49.8-41.5 = 8.30 Mn $ ( calculated as below)
Total laibilities excluding equity in 2013 = (122.5 -15-66) = 41.5 Mn $
Libility to sales ratio = 41.5/350 = 0.12
Liability for 2014 = 420*0.12 = 49.80 Mn $
c. Increase in retained earnings = Retained earning in 2014 ( 420 * 3%*(1-payout ratio i.e, 40%) = Retained earning in 2013 ( 10.5-4.2) =7.56 - 6.3 = 1.26 Mn $
Therefore,External capital requirments = 24.5 - 8.30 - 1.26 = 14.94 Mn $
2. Using AFN equation , if the firm does not go for external funds , then it needs to get the additional fund requirement from its retained earnings.
Retained earnigs for 2014 = 7.56. add to it the additional requirement of 14.94 = 22.5 Mn $
If 22.5 is the retained earning , therefore profit for 2014 = 22.5/0.60 = 37.5.
Firms expected growth rate = 37.5/ 420 = 9%
Additional Funds Needed = Ao × S Lo × S × S1 × PM × b So So