A firm is planning its operations for next year. Data for use in the forecast ar

Question

A firm is planning its operations for next year. Data for use in the forecast are shown below. Use this expression EFN = A*/S0(?S) – L*/S0(?S) - mS1(RR) to determine the required amount of external funds. State the relevant assumption imposed on the analysis.

Last year’s sales S0 = $350

Sales growth rate g = 30%

Last year’s total assets A0 = $500

Last year’s profit margin m = 7.5%

Last year’s accounts payable = $40

Last year’s notes payable to bank = $50

Last year’s accruals = $30

Target payout ratio = 55%

Explanation / Answer

Required increase in assets=(Current total asset)* (percentage increase in sales)=A0*((S1-S0)/S0)

Total assets =A0=$500

S0=$350

Increase in sales=0.3*$350=$105

S1= Next years Sales=(350+105)=$455

Required increase in Assets= $500*(105/350)=$150…(A)

Spontaneous increase in liabilities=(accounts payable)* (percentage increase in sales)

Spontaneous increase in liabilities=$40*0.3=$12…..(B)

Increase in retained earning =(Profit margin)*(Sales)*(Retention ratio)

Dividend Payout Ratio=55%=0.55

Retention Ratio(RR)=1-(Dividend Payout Ratio)=1-0.55=0.45

Profit Margin=m=7.5%=0.075

Sales=S1=$455

Increase in retained earning=0.075*455*0.45=$15.36…..(C)

External Finance Required=(A)-(B)-(C)=150-12-15.36= $ 122.64

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