Orange Company is evaluating its financing requirements for the coming year. The
ID: 2666521 • Letter: O
Question
Orange Company is evaluating its financing requirements for the coming year. The firm has been in business for only three years, and the firm’s chief financial officer (Erica Stevens) predicts that the firm’s operating expenses, current assets, and current liabilities will remain at their current proportion of sales.Last year Orange had $20 million in sales with net income of $1 million. The firm anticipates that next year’s sales will reach $27 million with net income rising to $2 million. Given its present high rate of growth, the firm retains all its earnings to help defray the cost of new investments.
The firm’s balance sheet for the year just ended is found below:
12/31/09
% of Sales
Current assets
$4,000,000
20%
Net fixed assets
8,000,000
40%
Total Assets
$12,000,000
Accounts payable
$3,000,000
15%
Long-term debt
2,000,000
NA
Total Liabilities
$5,000,000
Common stock
1,000,000
NA
Paid-in capital
1,800,000
NA
Retained earnings
4,200,000
NA
Total Equity
7,000,000
NA
Total Liability & Equity
$12,000,000
Estimate Orange’s total financing requirements for 2010 and its net funding requirements.
Orange Company is considering manufacturing communication equipment for the military. The average selling price of its finished product is $175 per unit. The variable cost for these same units is $140 per unit. This project incurs fixed costs of $550,000 per year.
What is the break-even point in units for the project?
What is the dollar sales volume the firm must achieve to reach the break-even point?
What would be the firm’s profit or loss at the following units of production sold: 12,000 units? 15,000 units? 20,000 units?
Explanation / Answer
I had answered this last night, but I guess it didn't show up. Anyway here we go! So the first question they ask us is what funding we need to finance our likely balance sheet for the next year. To complete funding we will either have to issue LT debt or equity. I am going to assume your professor wanted to issue additional LT Debt to finance this business. Here is our new Balance Sheet. The question states that many of the BS accounts are to remain as a % of sales. So all we have to do is change those accounts based on the new sales number and keep everything else the same. Current assets = 5.4M Net Fixed Assets = 10.8M Total Assets = 16.2M AP = 4.05M LTD = 2.0M Liabilities = 6.05M Common Stock = 1M Paid in Cap = 1.8M Retained Earnings = (recall that Beginning RE + Net Income - Dividends = End RE) Since we are retaining all earnings and not issuing a dividend our equation is 4.2M + 2M = 6.2M Total Equity = 1M + 1.8M + 6.2M = 9M Recall that a Balance Sheet must balance (hence the name :P) The equation to balance this is Assets = Liabilities + Shareholders Equity. We know Assets = 16.2M and Liabilities + Equity is 15.05M. This mismatch is the funding shortfall we must close. In order to close this, we must issue additional debt and increase our LT debt account. The difference is 1.15M and we must add this amount to the $2M in debt we already own. Hence the NEW LT debt account must be 3.15M. This will make the Balance sheet balance. On the fixed cost question we must use the equation, [Q*(P-VC)] - FC = Profit where: P = price per unit VS = variable cost per unit FC = fixed cost (this is a static, fixed number. It doesn't change no matter how big or little Q gets.) Q = quantity or the number of units sold So if P=175, VC=140, FC = 550,000, our equation would look like [Q*(175-140)] - 550,000 = Profit. Now to find the Break Even number of units, we must solve for Q when Profit is equal to zero. Plug zero into Profit and solve for Q and we get 15174.3 Since we cannot make a fractional unit we must round up to 15,715. This is the Q we must produce to break even. Now given specific Q's or quantities of units we will produce, all we have to do is plug them into our equation above, but this time we are solving for Profit instead of Q. Equation again is: [Q*(P-VC)] - FC = Profit [12,000*(175-140)] - 550,000 = -130,000 [15,000*(175-140)] - 550,000 = -25,000 [20,000*(175-140)] - 550,000 = 150,000 Hope this helps!
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