If sales and dividends increase, how does this effect current ratio and debt rat
ID: 2655090 • Letter: I
Question
If sales and dividends increase, how does this effect current ratio and debt ratio? (this is in relation to part B of the attached problem)
Woods Company: Balance Sheet as of December 31. 2015 thousand) Cash Accounts receivable Inventories Accounts payable Accruals Notes payable S 160 40 252 S 452 1,244 1,605 939 S4,240 Toal liabilities and equity S4,240 S 80 240 720 Current assets Fixed assets $1,040 Current liabilities Long-term debt Common stock Retained earnings 3,200 Total assets Woods Company: Income Statement for the Year Ending December 31. 2015 S thousand) Sales Operating costs Earnings before interest and taxes Interest Earnings before taxes Taxes (40%) Net income S 8,000 450 S 550 ( 150) $ 400 (160) S 240 Per-Share Data Common stock price Earnings per share (EPS) Dividends per share (DPS) S 16.96 S 1.60 S 1.04 The firm operated at full capacity in 2015. During 2016, it expects sales to increase by 20 percent and dividends per share to increase to $1.10. Use the projected balance sheet method to determine how much outside financing is required, develop the firm's pro forma balance sheet and income statement, and use AFN as the balancing item a. b. If the firm must maintain a current ratio of 2.3 and a debt ratio of 40 percent, how much financing, after the first pass, will be obtained using notes payable, long-term debt, and common stock? Create the second-pass financial statements by incorporating financing feed backs and using the ratios calculated in part (b). Assume that the interest rate on debt averages 10 percent. C.Explanation / Answer
Increase in sales leads to increase to current assets like cash, stock, debtors and bills receivables and also in current liabilities of creditors and bills payables. It will affect the current ratio with the increase or decrease of working capital (current assets – current liabilities).
Dividends are paid out of profits, and thereby reducing the balance in the Profit/Loss account (retained earnings). A decrease in the Profit/Loss account has an effect on the Own funds used in the calculation of debt ratio.
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