Problem 1. Forecasting (19 points) Garlington Technologies Inc.s 2016 financial

Question

Problem 1. Forecasting (19 points) Garlington Technologies Inc.s 2016 financial statements are shown below Balance Sheet as of December 31, 2016 Cash Receivables Inventories S 280,000 Accounts payable 560,000 Notes payable 120,000 820,000 Accruals 180,000 Total current assets $1,660,000 Total current liabilities 456,000 1,040,000 Long-term debt Fixed assets 700,000 1,300,000 244,000 $2,700,000 Total liabilities and equity $2,70000 Common ssock Retained carnings Total assets Income Statement for December 31, 2016 Sales Operating costs 3.279.720 $3,600,000 S 320,280 18.280 Interest Pre-tax camings $ 302,000 Taxes (40%) Net income Addition to RE Dividends S 181.200 73,200 s 108,000 Forecast the financial statsments (BOTH the balance sheet and the income statement) using the forecasted financial statement method and all the information below. Show the amount of financing neoded (ie. increase in notes payable) to support growth in sales. You can use the AFN equation for forecasting the financing need, as long as you make the nocessary adjustments for various changing ratios. -Suppose that in 2017 sales increase by 10% over 2016 sales and that 2017 dividends will double 10 5216,000. Assume the firm operated at 90% of capacity of its fixed assets in 2016. assets, If no extra fixed assets are required, the Ein therewiredioeloffisal fixed assets category on the balance sheet remains in operational efficiency will result in reduced operating costs relative to sales: Operating Costs2017 .85% Sales 2017 - The firm operates all its current assets at full capacity, therefore they will grow proportional to the sales on the pro forma balance sheet. Use an interest rate of 10%, and assume that any new debt will be added at the end of the year (so forecast the interest expense based on the debe balance (LTD+NP) at the beginning of the year). Assume that the all new debt will be in the form of a notes payable. No new common equity will be issued. Calculate ROF for 2016 and 2017 using DuPont equation (its full form). What is the driver behind increasing ROE: cost controls (PM), efflective asset management (TATO) or financial leverage (EM)?

Explanation / Answer

BALANCE SHEET 2016 Basis of projection 2017 Cash 280000 7.78% of sales 308000 Accounts receivable 560000 15.56% of sales 616000 Inventory 820000 22.78% of sales 902000 Current assets 1660000 1826000 Net fixed assets 1040000 1040000 TOTAL ASSETS 2700000 2866000 Accounts payable 120000 3.33% of sales 132000 Notes payable 156000 156000 Accruals 180000 198000 Current liabilities 456000 486000 Long term debt 700000 700000 Common stock 1300000 1300000 Retained earnings 244000 +435983 679983 TOTAL LIABILITIES & EQUITY 2700000 3165983 AFN $         -2,99,983 There is no need for external funds; funds are in excess to the extent of $299,983. INCOME STATEMENT Sales 3600000 +10% 3960000 Operating costs 3279720 85% of sales 2787762 EBIT 320280 1172238 Interest 18280 856000*10% 85600 Pre-tax earnings 302000 1086638 Taxes (40%) 120800 434655 Net Income 181200 651983 16.46% Dividend 108000 216000 33.13% Retained earnings 73200 435983 AFN USING EQUATION: AFN = (A/S)*(Delta sales) - (L/S)*(Delta Sales) - Profit Margin*Forecast sales*(1-Dividend payout ratio) - New common stock = (1660000/3600000)*360000-(300000/3600000)*360000-3960000*16.46%*(1-33.13%) - 0 = $        -2,99,869 ROE: ROE = (NI/Sales)*(Sales/Total Assets)*(Total Assets/Equity) 2016 2017 NI 181200 651983 Sales 3600000 3960000 Total Assets 2700000 2866000 Equity 1544000 1979983 NI/Sales 5.03% 16.46% Sales/Total Assets 1.33 1.38 Total Assets/Equity 1.75 1.45 ROE 11.74% 32.93% The cost drivers for increasing ROE are PM, TATO and EM. For 2017, though all three have increased, PM has increased most by 11.43 percentage points, leading to increase in ROE by 21.19 percentage points.

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