Sales and costs in 2016 are projected to be 20% higher than in 2015. Both curren

Question

Sales and costs in 2016 are projected to be 20% higher than in 2015. Both current assets and accounts payable are projected to rise in proportion to sales. The fixed assets of Growth Industries are operating at only 75% of capacity. Interest expense in 2016 will equal 10% of long-term debt outstanding at the start of the year. The firm will maintain a dividend payout ratio of .40.

What is the required external financing over the next year?

Even if sales increase by 20%, the firm still has more than enough fixed assets to meet production. Only working capital will increase. Net working capital of the firm in 2015 was $. The increase in net working capital will be $, which is less than the increase in the retained earnings. Thus required external financing is $. A negative external financing value indicates the firm will generate more cash than it needs to finance the projected growth. This extra cash can be used to reduce debt, repurchase shares, increase cash reserves, or fund future growth. This extra cash was primarily due to the firm's excess production capacity.

The 2015 financial statements for Growth Industries are presented below:

Explanation / Answer

Solution:

Income statement

Balance sheet

Now the long term debt for 2016 would be
Total liabalities and equity - Total equity - Account payables
= 338,000 - 117,750 - 13,200
= 207,050
Hence the long term debt declined to 207,050 in 2016 from 250,000 in 2015

Also calculating working capital
= Current assets - Current liabilities
= Current assets - Account payables
= 40,000 - 11,000 = 29,000 (2015)

Similarly calculating for 2016
Working capital = 48,000 - 13,200 = 34,800
Change in working capital = 34,800 - 29,000 = 5,800
But change in working capital is less than the increase in retained earnings (48,750)

Hence, there is no external financing required as retained earnings are sufficient to meet the working capital requirements of the firm

In $ 2015 2016 Sales (growth of 20% in 2016) 350,000 420,000 Costs (growth of 20% in 2016) 225,000 270,000 EBIT(Sales-costs) 125,000 150,000 Interest 25,000 25,000 PBT (EBIT-Interest) 100,000 125,000 Tax (35% of PBT) 35,000 43,750 Net income (PBT-Tax) 65,000 81,250 Dividends (40% of net income) 26,000 32,500 Retained earnings (Net income-Dividend) 39,000 48,750 (will flow to balance sheet)

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