Question

Financing Deficit

Stevens Textile Corporation's 2019 financial statements are shown below:

Balance Sheet as of December 31, 2019 (Thousands of Dollars)

Cash	$ 1,080		Accounts payable	$ 4,320
Receivables	6,480		Accruals	2,880
Inventories	9,000		Line of credit	0
Total current assets	$16,560		Notes payable	2,100
Net fixed assets	12,600		Total current liabilities	$ 9,300
			Mortgage bonds	3,500
			Common stock	3,500
			Retained earnings	12,860
Total assets	$29,160		Total liabilities and equity	$29,160

Income Statement for December 31, 2019 (Thousands of Dollars)

Sales	$36,000
Operating costs	34,000
Earnings before interest and taxes	$ 2,000
Interest	160
Pre-tax earnings	$ 1,840
Taxes (25%)	460
Net income	$ 1,380
Dividends (40%)	$    552
Addition to retained earnings	$ 828

Stevens grew rapidly in 2019 and financed the growth with notes payable and long-term bonds. Stevens expects sales to grow by 20% in the next year but will finance the growth with a line of credit, not notes payable or long-term bonds. Use the forecasted financial statement method to forecast a balance sheet and income statement for December 31, 2020. The interest rate on all debt is 11%, and cash earns no interest income. The line of credit is added at the end of the year, which means that you should base the forecasted interest expense on the balance of debt at the beginning of the year. Use the forecasted income statement to determine the addition to retained earnings. Assume that the company was operating at full capacity in 2019, that it cannot sell off any of its fixed assets, and that assets, spontaneous liabilities, and operating costs are expected to increase by the same percentage as sales. Determine the required line of credit. Do not round intermediate calculations. Round your answers to the nearest dollar.

LOC: $  

Answer 1

Additional Funds Needed = [A0 x (ΔS / S0)] - [L0 x (ΔS / S0)] - [S1 x PM x b]

Where,
A_o = current level of assets
L_o = current level of liabilities
ΔS/S_o = percentage increase in sales i.e. change in sales divided by current sales
S₁ = new level of sales
PM = profit margin
b = retention rate = 1 - payout rate

Payout Ratio = Dividends / Net Income = 552 / 1380 = 0.40

Profit Margin = Net Income / Sales = $1,380 / $36,000 = 0.0383

AFN = [$29,160 x 0.20] - [($4,320 + $2,880) x 0.20] - [($36,000 * 1.20) x 0.0383 x (1 - 0.40)]

= $5,832 - $1,440 - $993.60 = $3,398.40

Forecasted Line of credit = Notes Payable + AFN = $2,100 + $3,398.40 = $5,498.40