Question

EXCESS CAPACITY

Krogh Lumber's 2016 financial statements are shown here. Krogh Lumber: Balance Sheet as of December 31, 2016 (Thousands of Dollars) Cash $1,800 Accounts payable $7,200 Receivables 10,800 Notes payable 3,472 Inventories 12,600 Accrued liabilities 2,520 Total current assets $25,200 Total current liabilities $13,192 Mortgage bonds 5,000 Net fixed assets 21,600 Common stock 2,000 Retained earnings 26,608 Total assets $46,800 Total liabilities and $46,800 equity
a. Assume that the company was operating at full capacity in 2016 with regard to all items except fixed assets; fixed assets in 2016 were being utilized to only 75% of capacity. By what percentage could 2017 sales increase over 2016 sales without the need for an increase in fixed assets? Round your answer to two decimal places.

b. Now suppose 2017 sales increase by 30% over 2016 sales. Assume that Krogh cannot sell any fixed assets. All assets other than fixed assets will grow at the same rate as sales; however, after reviewing industry averages, the firm would like to reduce its operating costs/sales ratio to 82% and increase its total liabilities-to-assets ratio to 42%. The firm will maintain its 60% dividend payout ratio, and it currently has 1 million shares outstanding. The firm plans to raise 35% of its 2017 forecasted interest-bearing debt as notes payable, and it will issue bonds for the remainder. The firm forecasts that its before-tax cost of debt (which includes both short- and long-term debt) is 12%. Any stock issuances or repurchases will be made at the firm's current stock price of $40. Develop Krogh's projected financial statements. What are the balances of notes payable, bonds, common stock, and retained earnings? Round your answers to the nearest hundredth of thousand of dollars.

Answer 1

Krogh Lumber
Balance Sheet as on December 31, 2016
					All amounts are in '000 $
Assets	2016	2017	Liabilities	2016	2017
Cash	1,800.00		Accounts Payable	7,200.00
Receivables	10,800.00		Notes Payable	3,472.00
Inventories	12,600.00		Accrued Liabilities	2,520.00
Total Current Assets	25,200.00		Total Current Liabilities	13,192.00
			Mortgage Bonds	5,000.00
Net Fixed Assets	21,600.00		Common Stock	2,000.00
			Retained Earnings	26,608.00
Total Assets	46,800.00		Total Liabilities and Equity	46,800.00
a) Sales for the year 2016 = 36000
This is at 75% utilization of fixed assets. Hence, if the assets utilization is done at 100%
Sales will be = 36000/75%
48,000.00
Therefore, increase in sales will be
= (48000-36000)/36000*100
33.33%
b)
With an increase in sales by 30% sales amount will be
46800
Krogh Lumber Proforma Income Statement December 31, 2017
Particulars	2016	2017
Sales	36,000.00	46800.00
Operating costs (includes depreciation)	30,783.00	38376.00	taken at 82% of sales
EBIT	5,217.00	8424.00
Interest Expenses	1,017.00	2739.74	total liabilities * 12%
EBT	4,200.00	5684.26
Taxes (40%)	1,680.00	2273.70
Net Income	2,520.00	3410.55
Dividends	1,512.00	2046.33	60% of net income
Addition to RE	1,008.00	1364.22
Krogh Lumber Proforma Balance Sheet December 31, 2017
Particulars	2016	2017
Assets
Cash	1,800.00	2,340.00	adding 30% to 2016 Nos.
Accounts Receivable	10,800.00	14,040.00	adding 30% to 2016 Nos.
Inventories	12,600.00	16,380.00	adding 30% to 2016 Nos.
Fixed Assets	21,600.00	21,600.00
Total Assets	46,800.00	54,360.00
Liabilities and Equity
Payables + Accruals	9,720.00	7,990.92	Taken as 35% of Total Liabilities assuming all liabilities are interest bearing
Short term bank loans	3,472.00	3,472.00	As no information is given about this it is assumed unchanged.
Total Current Liabilities	13,192.00	11,462.92
Long term bonds	5,000.00	11,368.28	Total Liabilities - Current Liabilities
Total Liabilities	18,192.00	22,831.20	Taken from working below
Common Stock	2,000.00	3,556.58	Taken as, 31528-27972.22. Therefore, 38914.50 i.e. 38915 common stocks have been issued at $ 40/unit
Retained Earnings	26,608.00	27,972.22	Opening bal + current year addition
Total Common Equity	28,608.00	31,528.80
Total Liab. And equity	46,800.00	54,360.00
To keep Assets to liabilities ratio at 42%, liabilities would be
=54360 * 42%
22831.20