A company has the following balance sheet: Cash $ 200 Accounts payable $ 200 Acc
ID: 2705291 • Letter: A
Question
A company has the following balance sheet:
Cash $ 200 Accounts payable $ 200
Accounts receivable 200 Notes payable 400
Inventory 200 Long-term debt 800
Fixed assets 1,800 Common stock 800
Retained earnings 200
Total assets $2,400 Total liabilities & Equity $2,400
Sales for the year just ended were $6,000, and fixed assets were used at 80 percent of capacity. Current assets and accounts payable vary directly with sales. Sales are expected to grow by 20 percent next year, the expected net profit margin is 5 percent, and the dividend payout ratio is 80 percent.
How much additional funds (AFN) will be needed next year, if any?
Make sure to show all calculations!
Explanation / Answer
The first step is to express the Balance Sheet and Income Statement accounts which vary directly with Sales as percentages of Sales. This is done by dividing the balance for these accounts for the current year (1999) by sales revenue for the current year.
The Balance Sheet accounts which generally vary closely with Sales are Cash, Accounts Receivable, Inventory, and Accounts Payable. Fixed Assets are also often tied closely to Sales, unless there is excess capacity. (The issue of excess capacity will be addressed in External Financing Needed section.) For this example, we will assume that Fixed Assets are currently at full capacity and, thus, will vary directly will sales.
Retained Earnings on the Balance Sheet represent the cumulative total of the firm's earnings which have been reinvested in the firm. Thus, the change in this account is linked to Sales; however, the link comes from relationship betwen Sales growth and Earnings
The Notes Payable, Long-Term Debt, and Common Stock accounts do not vary automatically with Sales. The changes in these accounts depend upon how the firm chooses to raise the funds needed to support the forecasted growth in Sales.
On the Income Statement, Costs are expressed as a percentage of Sales. Since we are assuming that all costs remain at a fixed percentage of Sales, Net Income can be expressed as a percentage of Sales. This indicates the Profit Margin.
Taxes are expressed as a percentage of Taxable Income (to determine the tax rate). Dividends and Addition to Retained Earnings are expressed as a percentage of Net Income to determine the Payout and Retention Ratios respectively.
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